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The next phase of Bitcoin investment

February 21, 2014: 4:18 PM ET

If venture capitalists want their Bitcoin startups to succeed, they may need to make one other investment.


FORTUNE -- Venture capitalists have invested around $100 million into Bitcoin-related startups, believing that the cryptocurrency will eventually take a major bite out of the global payments industry. Everything from digital wallets to merchant acceptance solutions. But if they don't help create a U.S. exchange, it all might be for naught.

Any one of these investors will tell you that widespread adoption is key to the success of their various startups. Venture capitalist Ben Horowitz, for example, recently bet blogger Felix Salmon that more than 10% of NPR listeners will have used Bitcoin to buy something within the next five years. Horowitz made the bet not only because he believes he'll win, but also because he needs to win (Andreessen Horowitz so far has invested nearly $50 million into the space).

A major barrier to Bitcoin adoption right now, however, is price volatility. The same thing that makes Bitcoin great for "currency" speculators is the exact same thing that makes it a nightmare for someone who just wants to have a more convenient (and possibly cheaper) way to buy gas or groceries. Same goes for merchants, even if they use instant conversion technologies on both ends of a transaction. Imagine how hard it would have been for early Internet companies to get users if PCs only turned on 50% of the time ("oops, guess I can't use AOL today").

RELATED: Why VCs are right to be crazy about Bitcoin

To reduce volatility, Bitcoin requires a liquid market where large investors -- including institutions and governments -- are comfortable participating. Regulated, and based in the U.S. (most likely in New York). Not only does liquidity beget liquidity, but it also begets reliability which begets adoption.

Not surprisingly, I've heard that several venture capitalists already are exploring the investment case for a regulated U.S. cryptocurrency exchange. And I know of at least one VC-backed company that is in serious talks to move forward this something like this, likely via a "seat" model.

But I'll go a step further: Even if VCs ultimately deem such an investment too risky as a standalone, they still should proceed as a sort of loss leader for their other Bitcoin investments (past and future). You can't destroy the payment rails without first creating your own reliable infrastructure.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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