Bitcoin transaction reversal and arbitration is built in. How it works.

Eli Dourado has a well written and easy to understand article about how Bitcoin transaction reversal and arbitration works. The feature built into Bitcoin is known as m-of-n or “multisignature” transactions. Here’s a brief extract:

The simplest variant is a 2-of-3 transaction. Let’s say that I want to buy goods online from an anonymous counterparty. I transfer money to an address jointly controlled by me, the counterparty, and a third-party arbitrator (maybe even Amex). If I get the goods, they are acceptable, and I am honest, I sign the money away to the seller. The seller also signs, and since 2 out of 3 of us have signed, he receives his money. If there is a problem with the goods or if I am dishonest, I sign the bitcoins back to myself and appeal to the arbitrator. The arbitrator, like a credit card company, will do an investigation, make a ruling, and either agree to transfer the funds back to me or to the merchant; again, 2 of 3 parties must agree to transfer the funds. This is not an escrow service; at no point can the arbitrator abscond with the funds.

The full article is on Eli’s blog.

Another feature of the currency that adds intrinsic value, along with no intermediaries, very fast transaction time and negative inflation which makes it a great value store.

How to Buy Bitcoin

As someone who recently purchased Bitcoin and two other crypto currencies using three different methods, I thought I’d share how to buy Bitcoin because I know there’s precious little information out there:

Coinbase:

The easiest way I found without leaving your computer is to sign into Coinbase.com and add your bank account. They’ll do 2 small deposits, you need to wait around 2 days for them to show up, then you verify your account by telling them what the deposits were. Once that’s done you can make your first Bitcoin buy using coinbase.

NOTE that when buying with Coinbase, you only get to make one purchase until it clears which takes around 7 days right now. So buy whatever the maximum bitcoin is that you want to purchase on Coinbase in the next week. The good news is that the bitcoin price will lock in at the time of purchase so even though you’ll only be able to spend your bitcoin after the transaction is approved 7 days later, you still benefit from locking in the price at the time of purchase. For me that meant several hundred dollars in gains because the price was rising steeply when I bought and it continued to rise over the next week.

The benefit of Coinbase is that you don’t need to leave your computer to do it and you don’t need to meet strangers in a dark alley (see below). The down side is that it takes 7 days before you can spend your bitcoin and you need to give them your bank account details.

In Person:

LocalBitcoins.com is a reputable site which is popular with the Reddit community and they have ads for people local to you who are selling Bitcoin. The sites popularity has grown enormously in the last few months and every town world-wide (including South Africa) that I’ve checked has bitcoin for sale.

LocalBitcoins has a reputation system similar to eBay that lets you find someone who has a good reputation for not scamming folks. I found someone in Denver, Colorado yesterday and within about 30 minutes of contacting them via the site they phoned my cellphone. We arranged to meet in a parking lot outside a well known computer store. The guy was a typical twenty-something computer geek type – really nice guy actually. I was happy to give my first name but he seemed to want to go by his online handle. I handed him a rather large stack of cash and then we spent a few minutes figuring out what the best way was to send the Bitcoin. I ended up using the Bitcoin wallet for Android, he scanned my QR code, sent me the coins at the current localbitcoins.com exchange rate (which was quite good) and within 10 seconds my phone went KACHING and I had my Bitcoin. We said our goodbyes and that was it. Except…..

PRO TIP: If you’re buying Bitcoin from someone in person, make sure they include a small transaction fee with the Bitcoin when they send you the coins. If they don’t, the coins will show up in your wallet but it may take several days until you can actually spend them. The guy I was buying from had a wallet that added zero transaction fee and I had to wait just under 5 hours until the transaction was finally completed by the network and the coins became spendable. I did a few tests later and added everything from 10 US cents to $9 as a transaction fee and it radically improved the processing time. The $9 transaction fee took 30 minutes to complete and when adding a few cents it takes about an hour. Many wallets don’t give you the option of adding a transaction fee. The Bitcoin-QT client does give you that option and I understand that the “Mycelium wallet” for android lets you modify the transaction fee but I haven’t verified this. The miners who process your transaction get the fee and they prioritize transactions with fees associated with them first.

The benefits of buying in person are that you get your bitcoin immediately and you usually get a better price that you do if you’re buying at an exchange or a service like Coinbase. The down-side is obviously that you might get mugged or scammed. But with a reputation system like LocalBitcoins and meeting in a crowded place, there are ways to minimize that risk.

Buying on exchanges:

After buying bitcoin I wanted to buy some Litecoin and found BTC-e exchange which offers trading in several other Crypto currencies. Note that BTC-e is based in Bulgaria and no one knows who the owner is so it’s highly risky. You’ll notice that all crypto currencies are cheaper on this site and it’s because of the risk premium. So I send them some Bitcoin as a deposit and started trading – bought some Litecoin which has yielded a nice profit along with some Feathercoin which is still extremely cheap and new and has also behaved quite nicely since the purchase.

I haven’t used Mtgox, but I understand that it only offers Bitcoin trading at this point which seems a little pointless because that doesn’t really make it an exchange – more of a place to buy Bitcoin like Coinbase.

Conclusion and my recommendation:

If you’re going to buy Bitcoin in the USA at this point, and if I buy again, I’ll definitely buy in person. It’s very fast, fun and with the reputation management that LocalBitcoins offers it seems fairly safe. If you have patience, Coinbase seems like a good option but in a fast moving market it moves a little too slowly for my liking.

Happy crypto currency trading!!!

Update:

Since I posted this 6 days ago, I’m still trading occasionally on BTC-e, but only alternative crypto currencies. I do all my Bitcoin buying on Coinbase. Today there were claims on Reddit that some folks couldn’t get their money out of BTC-e. Turns out BTC-e’s email servers were down for a while, so anyone who had email verification for withdrawals couldn’t withdraw their money. Sounds like an honest bug that hit BTC-e. I’m still quite happy there although I never leave a positive balance on the system. I’ll deposit, trade and then get out. Also note that they charge 0.1 Litecoins (About $4 today) for a litecoin withdrawal and .001 Bitcoins (About $1.20 today) for a Bitcoin withdrawal. The Litecoin folks are up in arms about this.

Since I wrote this I’ve made another trade on Coinbase on Dec 1st and am happy, although the delay to get coins is 6 days, even for your second trade. [Rather than the 4 days I wrote in the comments below]

I’ll also note that since the writing of this article I have been trading more alternative crypto currencies including Litecoin, PrimeCoin and Feathercoin. There is a lot of “pump and dump” activity around these currencies. They’re being treated like penny stocks. A cartel of people will get together, spend a few hours either boosting or insulting a particular currency to try and generate buy or sell activity, take the opposite action, and then send the opposite message. They use forums, live chat, twitter, blogging and so on. Litecoin is getting too large in market capitalization to do this (passed $1 billion compared to Bitcoin’s $13 billion and the third place Peercoin’s $136 million market cap). But smaller crypto currency perception is being manipulated by groups of folks, so beware. I still think it’s fine to trade in these currencies, but wait for a drop to buy and ignore the intra-day noise you see on forums and social media.

 

A Viable Business Model for Facebook

Facebook’s second quarter revenue is expected to be $1.1 billion. That would give them roughly $4.4 billion per year, not exactly a number that justifies the $100 billion market cap they were/are hoping for. Compare that to Google’s $37 billion last year with current $200B market cap and Facebook isn’t even a player yet.

The endgame has arrived and the whole world is on Facebook today. Those that aren’t are seen as eccentric and are beginning to get depressed about losing touch with their kids.

What business model would make sense for Facebook now? Clearly advertising isn’t cutting it. They have a problem of “intent”. People go to Google to find things and if those things are in an ad, they click that ad. With Facebook the only intent is to “facebook”, not find a plumber and potentially click an ad. So as far as I’m concerned advertising will never work for Facebook.

So what should they do? Well, for starters, they have a dossier on just about every literate person on the planet with Internet access. Their data extends beyond just their own website facebook.com. They have data on most of the websites their members visit and what those members do on each website. They know who you are, where you are, who your friends are, who their friends are, where you were born, what you and your friends look like, who you communicate with most frequently, what you like, which websites you visit most frequently, how you get to those websites,  which pages you visit on those websites and all the usual demographic cruft.

In short, Facebook is the most complete and most current database of dossiers on individuals globally that the world has ever seen and it’s effortlessly updated in real-time.

So who might be interested in that? Any intelligence agency on the planet. Is there any money in that? Lets find out.

The Department of Defense in the United States 2013 budget is going to be roughly $525 billion. How much of that might they spend on surveilling people globally in real-time? Looking at the budget for the National Reconnaissance  Office (NRO), the guys who launch and manage our spy satellites, is instructive.

The NRO’s budget for 2010 was roughly $15 billion. If Facebook can also be considered a global array of data gathering nodes similar to our spy satellites, then surely $15 billion would be a reasonable number to throw around in a conversation with the folks who launch and operate the data gathering nodes?

And that’s one customer, albeit the largest customer. Remember that the USA has intelligence partners around the world. An example of this is the five signatory states in the UK-USA signals intelligence sharing agreement which are: USA, UK, Canada, Australia and New Zealand. All these folks have significant budget they can also contribute.

Another budget item that might be instructive to look at is the cost of ECHELON which is not public data. But the scale, size, importance and multi-decade nature of the project (started in the 70’s and still going strong) is a good illustration of how seriously the USA and it’s partners take signals intelligence and the scale of the budget available for it.

To be a “Google”, Facebook would have to bring in $40 billion a year in revenue which would take them to Google’s valuation of $200 billion. Right now they’re stuck at $4 billion a year.

Facebook is the only social network that matters and will be forever thanks to it’s network effect. It’s hard to believe that the smart people Facebook keeps gobbling up haven’t considered chatting to the global intelligence gathering and cyber security community. The data they have is game changing and something the global SIGINT community would never be able to gather on their own.

Trying to visualize the conversation Zuckerberg might have with the global intelligence community, it reminds me of a quote by Richard Gere’s character in Primal Fear who is a famous defense lawyer describing the conversation he has with new clients: “Have you been saving up for a rainy day? Guess what? … it’s raining!”

Footnote: There is the hard problem that publicly working with the intelligence community would kill Facebook. But then the intelligence community has never been very public and one wanders if there are ways to productize the desired data into something that appears benign and have contractors buy it on the agency’s behalf. Food for thought.

11 Questions Every Startup’s Money Guy Should Be Able to Answer in Her Sleep.

Every profitable business has a Money Guy. Sometimes it’s the CEO, sometimes it’s another member of the exec team. Money sticks to this persons hands for reasons unknown. They know how to get the best deals for anything they buy and they have a habit of making more money than they lose. If you don’t have someone like this in your business then you are almost certainly not profitable and never will be.

Often this persons title is Chief Financial Officer or Chief Operating Officer. They are the ones who update the cash flow plan and know how much cash the business has on hand at all times. They are the money guy. You’ll know your money guy rocks when you wake them up in the middle of the night and they answer every one of these questions as if it’s a reflex:

  1. When do we run out of money?
  2. What is our next revenue target date and amount?
  3. Are we going to make our target or are we slipping?
  4. What are the two most effective things we can do to increase revenue?
  5. How are we doing with regards to implementing those 2 most effective things?
  6. What are our top two sources of customers?
  7. Are either of those sources at risk of disappearing overnight?
  8. What are our two biggest expenses?
  9. Have we done everything we can to lower those expenses?
  10. Are we at risk of facing a large bill in the near future?
  11. Now that you’ve been woken up, is there any current or future problem in the business that will make it hard to go back to sleep?

Other awesome Money Guy attributes:

  1. Your Money Guy discovers surprising ways to save significant amounts of cash on big expenses.
  2. Your Money Guy isn’t constantly moaning or complaining, but occasionally will assemble the team and lay out hard facts that put some acid in your gut.
  3. Your Money Guy always has your important financial data on hand, often memorized for impromptu brainstorms or planning sessions.

The culture I’ve described here is unfortunately not what you find in most nascent businesses which is why most of them fail to make that critical four year mark. Also not that this does not apply, or put differently it is unable to be applied to the paralel universe of West Coast Technology Startups in the USA. But it’s something I’ve observed in businesses around the world including profitable USA businesses.

Often Money Guys are seen by tech entrepreneurs as people with green eyeshades who work under dim green lamps and aren’t fun at parties. But without the Money Guy, the parties end, entrepreneurs become employees and the innovation ends. Your Money Guy is the person who makes sure your business has enough oxygen to dive deep, take those big risks and come up for enough air to do it again.

To borrow or not to borrow: Thoughts on US government debt

A reputable investment bank approaches you and says they’ll lend you as much money as you want for a very low interest rate. The rate depends on how long you want to hang onto the cash:

  • 1 Month will cost you 0.01% APR interest
  • 6 months: 0.07%
  • 1 years: 0.11%
  • 5 years: 0.88%
  • 10 years: 2.02%

If you earn 3.5% on the money over 5 years which simply keeps pace with US inflation, when you pay back the principle you will be able to keep a 2.62% annual return on whatever you borrowed, based on the 5 year borrowing rate above. So if you borrow 1 million over 5 years you earn $138,046.62 in pure interest over 5 years (compounded annually).

Sounds like a pretty good deal right? $138K earned 5 years from now for nothing. I’d take it, assuming I could find somewhere to invest the money that would give me a 3.5% return, which shouldn’t be too hard.

However, if I’m fiscally irresponsible and rather than investing the cash I’m likely to spend it on hookers and blow, then it’s probably a bad idea for me to borrow as much as I can.

However, if I am that irresponsible and have a history of being a nut job, the interest rate that the investment bank charges me on my borrowings will reflect my lifestyle and will be more like 30% APR which is what many credit card companies charge once you’ve missed a payment.

The interest rates above are what America currently pays to borrow money. It’s the treasury yield curve rates. They are below inflation which means that the rest of the world pays the United States to store their money. And the United States makes money if they can get a very moderate return on any of that cash they invest. If the return simply keeps pace with inflation, they’re rolling in dough.

The interest rate the United States gets charged reflects how investment banks, sovereign wealth funds, companies and individuals feel about the United States “lifestyle” or fiscal and monetary level of responsibility.

So the question is: Can our country borrow trillions of dollars, put it to work in a responsible way and make out like a bandit? Or will it spend it all on hookers and blow and leave our grandkids in the hole struggling to pay off the principle?

Footnote: The answer to this question is usually along ideological lines. Keynsian economists like Paul Krugman who dominate the Democratic party will say Hell Yes! Government knows best and should borrow like there’s no tomorrow. Hayekian economists like Russ Roberts and economic conservatives on the other hand will tell you that the private sector knows best, government should limit it’s size and balance sheet and should never engage in massive borrowing no matter how low the interest rate or the potential return on investment, because it’s not government’s place to act like an investment bank.

Footnote2: I’m still feeling pretty good about my bull market prediction yesterday and am now long Apple (AAPL). I’m expecting it to churn during the next 6 months and have a 18 to 24 month price target of $550 (bought at $418).

Bull On.

I am long the stock market. I’ve been accumulating stock in businesses I understand for the last month or two. Why? I’m predicting a bull market starting in the next 12 months.

My reason for writing this is purely selfish. I want to be able to say I told you so. I’ve also been predicting armageddon for the last 10 years in the USA and it’s getting boring.

Here’s why a bull market is imminent:

  • We’ve so far dealt with a crisis in housing, money markets, mortgage backed securities, credit default swaps, commercial real-estate, municipal bonds, hedge funds collapsing due to over-exposure, the collapse of many small banks and collapse or almost-collapse of many larger ones, the risk of the FDIC running out of cash, our own country’s budget crises, legislative deadlock and sovereign debt crises both in the USA and Europe.
  • We’ve shone sunlight on all financial crises and there appears to be nothing coming down the pipeline except the latest report that China isn’t going to grow as fast as it was. Oh poo. Hell, the municipal bond crisis in the USA turned out to be the best performing fixed income investment in 2011 returning over 10%. Turns out local governments managed to cut costs, increase revenue and actually pay their debts.
  • American consumers have been paying down debt since 2008 and are flush with cash.
  • The DOW has been flat for 10 years. If you invested in the DOW 10 years ago your money is now worth 20% to 30% less in inflation adjusted terms.
  • Housing has flattened out and even Schiller is beginning to sound mildly optimistic that house values will start heading up within 12 months.
  • In real terms (inflation adjusted terms) housing isn’t down 30%, it’s down more like 45%. There isn’t anywhere else to go.
  • US corporations are more profitable than they’ve ever been and are priced attractively by any measure: P/E, P/S, Price/Book, etc. Companies like Intel are getting so frustrated at the crappy valuations they’re getting that they’re borrowing money to buy back their own stock and are paying 3% on debt rather than a 4%  to 5% dividend yield.
  • Europe doesn’t really matter and isn’t that bad. To use a recent example from James Altucher, Greece to the European economy is like Rhode Island to the USA. It just doesn’t matter.
  • Unemployment is 8.5%. During the great depression it was 25% so enough with this “things are so bad” bull. Even if you assume 16% real unemployment if you factor in those that have stopped looking for work, it’s still nowhere near great depression levels.
  • Besides reducing our debt, everyone I know has been living frugally and actually accumulating cash.

When I say I’m long the market, I’m long specific stocks that are awesome businesses, have growth potential, have a monopolistic like advantage that makes them very hard to compete against. Two examples:

  • Intel (INTC): Basically they have a monopoly on server CPU’s world wide. I’m betting that the massive growth in data centers world-wide is going to continue to drive record revenue at Intel. The machine you’re reading this on has a 90% chance of having an Intel CPU inside. More importantly, the data center that served this page is full of Intel CPU’s and it keeps growing.
  • Amazon (AMZN): I love Jeff Bezos. There, I said it. He almost literally gives investors the finger and just puts his head down and keeps growing. Amazon’s revenue growth in the last 10 years has been stellar and consistent. Bezos is investing heavily for the future, including building his own platform and app store to compete with Apple and Google and continuing to expand warehouse capacity. The business is also wonderfully diversified into retail, cloud services and digital media. AMZN is valued using Price/Sales since it doesn’t have net income to speak of or dividend yield, and in historical terms the P/S is low right now.
  • Apple (AAPL): So I was avoiding this stock just because there’s way too much hype around it, but turns out it’s undervalued in historical terms. Check out AAPL’s P/E for example. Also check out Apples market cap relative to Microsoft’s peak market cap in late 99 early 2000’s. If Apple is truly the next big platform, it’s cheap when you adjust MSFT’s peak market cap for inflation.

Other businesses I’m interested in: WalMart, Costco, Visa (although I don’t understand financial stocks so will probably avoid).

Keep in mind I’m taking a 18+ month view on these companies and to me a 10% annual return would be spectacular considering a 2 year CD will give you 1.2% if you’re lucky. I’m also comfortable losing the principle – I have a strong stomach for risk.

Disclosure: I’m currently long Intel and Amazon and will probably go long on Apple as soon as the current rally dies.

Unemployment is lower? Bull.

Last Friday and again today the DJIA got a nice bump from data showing unemployment has dropped from 9% to 8.6%. This number is known as U3 and only counts those actively looking for work. U4 is what the government should publish which counts U3 + those who have given up looking.

We “added 120,000 jobs in November” and have added over 100,000 jobs per month for the last 5 months.

I found the birth, death and marriage rate on the CDC website. For December 2009 we had 344,000 live births per month, 216,000 deaths per month and 138,000 marriages per month.

Our population is increasing by roughly 128,000 per month, which is 8000 more than the number of jobs we added. Looking at marriages per month gives you an indication of how many new couples are starting life and presumably expecting full employment. That’s 18,000 more than the maximum number of jobs we added per month in the last 5 months.

I don’t think we’re ever going to get the jobs we lost back because the financial crisis of 2008 was a trigger that caused companies that have become more efficient to cut a workforce that is no longer needed. That is why corporate revenue has not declined even though unemployment has increased. The grey marks the recession, click the graph to go to ycharts for a live version.

The only way to solve this is to bring our education syllabus up to date. The chinese have a few ideas how to do that: They’re cutting majors that produce unemployable graduates. 

Revenue and Runway – Why every cent matters

A month ago on Techcrunch, Michael Arrington wrote about “Twitter’s Revenue Dilemma”: “Your valuation can actually go down once you turn on revenue.”.

“Turning on revenue” frames it as a binary thing. You’re either making money or you’re not. It completely disregards the most important variable in finance: Time.

With the tiniest trickle of revenue you can extend your runway infinitely. That means you never have to raise another cent and you even have money to fund your growth. Let’s take an example:

Say you’re a consumer web business. You have some growth and some traction. You close an angel round for $400k in Month 1. In month 2 you start spending it and your burn rate is $25k for salaries, office and hosting. It takes you 4 months to get the product into shape and launch.

In your first month of launch you make a meagre $500 bucks. And lets say you suck at marketing and your revenue increases by $1000 per month so that a year after you launch your product (17 months after getting funded) you’re making $12,500 per month in revenue.

Even two years after getting funded you’re still only making $19,500 which is far from breaking even.

But what this does it it slows your burn rate enough and buys you enough time so that you never run out of money. That means you can keep paying yourself a full salary and growing your business and you never run out of cash. In month 29 your bank balance drops down to $12,500, but then it starts increasing again because in Month 30 you break even.

If you didn’t generate any revenue in the first 18 months you run out of money in month 17.

You might argue this approach stifles growth. So be more aggressive, increase your burn rate to $200k and raise $3 Million. The same logic applies. Early cash-flow that is far from break-even can extend your runway to infinity (and beyond).

This matters for founders more than anyone else because it means you can raise a single round and never have to give away any of your equity ever again.

The sheet below shows the two scenarios – with and without revenue. [I’ve reoriented the flows vertically for readability]