On March 18, 2013, the government dropped a bombshell on Coinbase, a two-man San Francisco startup that had attracted 30,000 users to its cloud-based “wallet” service for buying, storing and spending bitcoins.
That day the U.S. Financial Crimes Enforcement Network (FinCEN) released “interpretive guidance” stating that those administering or exchanging virtual currencies such as bitcoin should be considered “money transmitters,” subject to state licensing, federal registration and Bank Secrecy Act rules designed to help the feds uncover money laundering, tax fraud and other crimes.
Coinbase president Fred Ehrsam immediately called the company’s lawyer. “He said, ‘It’s [only] guidance, and you guys are small, and it’s going to be a pain in the butt to comply. It’s going to take a lot of your time and money to do it,’ ” Ehrsam recalls. “ So his advice to me was to try to make a good argument as to why it [registration] didn’t apply to us and avoid it for the time being.”
But that night Ehrsam and Coinbase CEO Brian Armstrong had a come-to-Jesus discussion. They agreed that skirting registration was wrong for their brand. While beloved by tech-savvy libertarians, bitcoin had taken a hit to its reputation after being sullied by hacks, Ponzi schemes and its use on the Silk Road dark-net drug market. Coinbase wanted to be seen as the easy, safe and legitimate way for a wider population to use cryptocurrency.
That week the pair fired their lawyer and hired a new one. They had been operating with $600,000 from angel investors and were trying to raise Series A funding. The decision to register would add millions to Coinbase’s costs but also give it a strong selling point. At that time the most well-known venture capitalist who had publicly expressed interest in bitcoin was Union Square Ventures partner Fred Wilson. When Ehrsam and Armstrong pitched USV, Wilson grilled them on their approach to regulation. Their compliant stance helped win them a deal.
In May 2013 USV led a $6.1 million Series A fundraising for Coinbase. In November the company got insurance (brokered by Aon) covering thefts and hacks. In December Andreessen Horowitz led a $25 million Series B round for it, the largest VC investment in a bitcoin firm to that date.
Today Armstrong, 33, and Ehrsam, 28, have 117 employees and are pillars of the cryptocurrency establishment. Coinbase’s wallet is used by 4.8 million customers from 33 countries to buy, store and spend bitcoin and a newer cryptocurrency, ether. Customers link their wallets to their regular bank accounts and pay Coinbase a commission–1.49% for U.S. account holders–to convert from or back to a government-issued currency.
A newer Coinbase business, the Global Digital Asset Exchange (GDAX), enables residents of 47 U.S. states, Canada, the U.K., the euro zone, Singapore and Australia to trade the currencies directly, either by manually clicking buy and sell buttons or by creating bots for algorithmic trading.
Coinbase stores about 6% of the world’s bitcoins, or some $700 million, on its computers. It gives customers the option of holding the only encryption keys to access their money or sharing the keys with Coinbase–protection if they lose the keys but an approach that rubs libertarians the wrong way.
Investors have poured $117 million into building Coinbase’s infrastructure and controls. In January 2015 Draper Fisher Jurvetson led a $75 million round that included investors such as the New York Stock Exchange, the insurer USAA and the Spanish banking group BBVA, among others. Coinbase’s most recent funding, $10.5 million in July, valued the enterprise at $500 million and drew money from Japan’s largest bank, Bank of Tokyo-Mitsubishi UFJ, ahead of Coinbase’s expected expansion into Japan next year.
Coinbase is now part of the establishment, and a strict enforcer of Bank Secrecy Act rules, in an industry fueled by those who value bitcoin as a way to protect privacy or thumb their nose at government. If it sees suspicious transactions in a wallet, it may demand that a user explain himself, or it may suspend or close the account.
No surprise that a chorus of Reddit users have accused it of acting like “Big Brother,” “spying for the U.S. government” and using “Gestapo” tactics. One disaffected Coinbase customer posted: “Wow, somebody clearly forgot the reason people use bitcoin in the first place. If I wanted to be questioned about where every transaction happens, I’d ask the IRS for an audit.”