It was a chance encounter on a beach in Ibiza, Spain, in the summer of 2012 that would lead to Cameron and Tyler Winklevoss becoming two of the biggest investors in Bitcoin.
While looking for lounge chairs, the Winklevoss twins ran into David Azar, a private investor from New York who offered them his seat.
Azar started talking about Bitcoin, the digital currency that has gained prominence this year.
“He asked us if we’d given much thought to virtual currency, and, at the time, we really hadn’t,” says Cameron Winklevoss, who along with his brother in 2004 sued Facebook founder Mark Zuckerberg, claiming he stole their idea for the social-networking site.
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“I got really fascinated by the implications for the financial world,” Cameron says.
Within weeks of their Ibiza sojourn, the brothers — flush with cash from the $65 million they won after settling the Facebook case in 2008 — started buying Bitcoins.
They aren’t the only ones to catch the Bitcoin bug. In the past six months, at least half a dozen venture-capital firms that made fortunes from early contrarian bets on tech companies such as Twitter, Tumblr, Skype and Spotify have put their money on Bitcoin.
After dismissing Bitcoin as a joke for years, many Silicon Valley investors now see digital currencies as the next revolution to hit the Web after social media.
In May, Founders Fund, set up by PayPal founders including Peter Thiel, led a $2 million investment in Atlanta-based BitPay, which allows merchants to accept Bitcoin payments and is processing transactions totaling about $7 million a month.
Also in May, after two years of wait and see, New York-based Union Square Ventures, an early investor in Twitter, put $2.5 million in Coinbase. Coinbase was processing $20 million worth of Bitcoins a month as of September, up from $1 million in February.
Then Google Ventures jumped into digital currency with undisclosed investments in OpenCoin, the company behind Ripple, which operates a payment system using Bitcoin.
The Winklevosses say they own about 1 percent of the $1.6 billion worth of Bitcoins in circulation, making their holdings worth about $16 million. They say they see Bitcoin as a way around a sclerotic global payment system that is Balkanized into rival currencies and competing financial institutions.
“We feel that digital currency, and Bitcoin for now, is a huge place for innovation,” Cameron says.
Bitcoin originated at the height of the financial crisis in November 2008, when a programmer or group of programmers known only as “Satoshi Nakamoto” released an academic paper outlining the design for a new peer-to-peer electronic cash system that removes the need to deal with third parties such as banks.
A few months later, in a blog post, Nakamoto described the idea for issuing encrypted digital coins that were not tied to any central bank.
Users store Bitcoins in digital wallets, with transactions recorded on the Blockchain, a public ledger that can be accessed via the Internet. The system Nakamoto designed caps the number of Bitcoins at 21 million.
The open-source Bitcoin protocol has been tested by some of the world’s top computer-security experts, who have tried to hack it and failed.
While anyone can see transactions made from a Bitcoin address — a string of about 34 numbers and letters — the owner remains hidden. The same goes for Nakamoto, whose identity remains a mystery.
No central authority issues Bitcoins, which is part of their appeal to libertarians, who form a significant cohort of the virtual currency’s supporters.
Skeptics compare Bitcoins’ appeal to the mania for Dutch tulip bulbs in the 1600s, when speculators drove up prices only to see the market collapse as investors rushed to sell. Others have branded Bitcoin fool’s gold, saying a digital code can’t be valued as a traditional commodity can.
“Bitcoin will be the Esperanto of the monetary world,” says James Angel, a finance professor at Georgetown University in Washington, D.C. “Most people will see it as a fad like hula hoops, and they’ll look back on it a decade from now and say, ‘That was a clever idea. I even bought a cup of coffee with it once.’ ”
Fad or not, Bitcoins are being adopted by a few merchants striving for cyber cred. You can use your Bitcoins to buy beer at Pembury Tavern in East London, cocktails at EVR bar in New York and dessert at Cups and Cakes Bakery in San Francisco.
Bitcoin exchanges and payment processors akin to PayPal have mushroomed, luring users to trust often-unregulated third parties to hold and handle their digital currency.
Regulators are cracking down on this Bitcoin free-for-all.
Earlier this month, the FBI arrested Ross Ulbricht, aka “Dread Pirate Roberts,” the alleged founder of Silk Road, a website that the FBI says was a platform for illegal drug sales.
Silk Road generated about $1.2 billion of sales using Bitcoins and $80 million in commissions, according to a criminal complaint unsealed in Manhattan federal court.
Ulbricht was charged with narcotics-trafficking conspiracy, computer-hacking conspiracy and money laundering. The FBI seized 26,000 Bitcoins worth about $3.6 million.
Earlier this year, in March, the U.S. Treasury’s Financial Crimes Enforcement Network issued guidelines requiring Bitcoin exchanges and processors operating in the U.S. to register with FinCEN as money-services businesses. The regulations — a costly headache for Bitcoin startups — require companies to follow the same “know-your-customer” rules that banks do and report suspicious transactions.
In May and June, the Department of Homeland Security seized $5 million from two U.S. accounts connected to one of the largest Bitcoin exchanges, Tokyo-based Mt. Gox, for failing to register as a money-transmitting business.
In June, Mt. Gox registered with FinCEN. In keeping with anti-money-laundering rules, it is now requiring users to verify their identities when they deposit or withdraw cash.
“For Bitcoin to succeed, the banks need to be on board,” says Shakil Khan, head of special projects at music-streaming service Spotify, an early investor in BitPay and backer of CoinDesk, a Bitcoin news site. “Living in hope that the regulatory challenges will disappear is not a strategy.”