Bitcoin has burst, but could still revolutionise banking

The bitcoin bubble has burst. This was wholly predictable, and the market fallout is now dramatic. In the past two months alone the cryptocurrency’s price in dollars has fallen about 44 per cent, according to coinbase.com. Having peaked last year at about $1,150, it was this week trading just below $330.

Playing the market now would be a bad idea. As there are still bitcoin backers happy to predict that the price could hit $10,000 within three years, the moment of capitulation has not yet arrived. And, in any case, its price is still about 160 per cent higher than it was two years ago; there is room to fall far further.

Proponents of bitcoin still talk in broadly messianic terms about its revolutionary potential. Its detractors denounce the idea as a Ponzi scheme or a “con”.

It is best to ignore this virulent debate, accept that cryptocurrencies will not displace banks or governments, and instead look at the plethora of possibilities that the venture capital industry is now exploring to use the technology platform at the heart of bitcoin.

The essential breakthrough of bitcoin is to allow two people to exchange money directly with each other, without the need of an intermediary, and to do it wholly digitally.

Before bitcoin, this was only possible in the physical world, with cash. As the payments system remains expensive and clumsy, there is a good chance that bitcoin technology could help.

Certainly Silicon Valley is betting that it will. According to the tally kept by coindesk, a total of $317m has been invested in bitcoin start-ups since 2012. The flow of money is accelerating, with $224m arriving this year. According to coindesk, there is greater venture capital activity in bitcoin this year than there was in the internet in 1995. The level of excitement is certainly comparable.

What are these start-ups doing? Typically they offer “wallets” to make it easier to hold bitcoin, and to make payments with it. There are even start-ups trying to introduce bitcoin to Africa.

They tend to share a philosophy that bitcoin is like “the internet before Netscape” to use the words of Jeremy Allaire, the founder of Circle, a start-up that enables users to pay each other using bitcoin over mobile phones. A currency protocol exists, but nobody has yet worked out how to make it easily usable. Therefore venture capital is flowing towards companies that make it easier to use bitcoin, in the hope that they are modern day versions of Netscape.

The issue these venture capitalists face is whether bitcoin has become “a solution in search of a problem”, as the laser was called in the early years after its invention. Bitcoin requires powerful computers. Few understand it. Are these start-ups trying to find a way to make the technology useful when something simpler would suffice?

Two of banking’s greatest problems are to make transactions viable for the poor who cannot afford to open an account, and to cut the fees for foreign exchange.

In east Africa, a service called m-Pesa, which allows the unbanked to exchange money with each other over conventional mobile phones, has sent shockwaves through the industry. In forex, services such as the UK’s TransferWise are using standard social networking to try to deal with foreign exchange. In this context, deploying bitcoin looks a little like taking a sledgehammer to smash a walnut.

It is more promising to look at the uses of the “blockchain” ledger that keeps account of bitcoin transactions. Richard Gendal Brown, who covers financial innovation for IBM, points out that developers have shown how different coloured coins, or even shares in different companies, could be issued and transacted over the same blockchain.

That is a way off. But if it were to happen, it could revolutionise the back office of banks and securities companies. Banks themselves seem excited by this.

Rather than arguing over bitcoin as a currency, the key questions for those raising money to invest in this technology are growing clearer. Can it save money? And what problem is it aiming to solve?

On this rather prosaic basis, even after the bubble, bitcoin might yet prove revolutionary. But the entrepreneurs must first come up with good answers to these questions.

john.authers@ft.com