I recently started to spend some more time on the Bitcoin ecosystem and while I have not yet fully wrapped my head around all of the opportunities and challenges (or even developed an investment thesis), I wanted to write down some early thoughts and observations.

Thoughts on the current ecosystem

The recent Bitcoin rally might be just the tip of the iceberg, as the crypto-currency may rise to even higher prices driven by destabilized national currency systems, greed and speculation, as well as illegal activity (i.e. the best way to get money out of China). Simon Winder has an interesting analysis how high Bitcoin can go.

While the majority of mainstream attention has focused on Bitcoin as a currency, Bitcoin may have a more interesting future as a protocol (see Albert Wenger’s post “Bitcoin as a Protocol”). At its core, Bitcoin provides a digital ledger that’s continually updated and synchronized in real time. Any participant can make an entry in the ledger, recording transactions from one participant to another participant. In this way, Bitcoin provides an unalterable framework for Proof of Ownership that can be used not only as currency, but also in a range of interesting applications like voting, property, contracts, domains, and securities.

It is still very early days for the platform but the two biggest opportunities for Bitcoin seem to be right now:

1. Disrupting traditional institutions that we used to rely on for trust-related services, such as banks, registrars, etc. The app Proof of Existence uses the Bitcoin network as an ultra-secure notary service. But imagine even broader use cases (as outlined here) such as:

• A will that automatically unlocks (without attorney intervention) when the heirs agree that the parent has passed away
• A wire escrow that goes through when any arbiter agrees that the seller sent the goods to the buyer
• A wallet that is socially secured by friends or family
• A crowdfunding project that pays out after reaching various milestones, based on the approval of the backers

2. Drive down transaction fees: This infographic compares the cost of sending $1K from the U.S. to Europe (for example, as a down payment for a vacation rental). Here’s the breakdown on transaction costs: Bitcoin – $15, Credit card – $50, and bank wire – $40-80.

The future of Bitcoin

Numerous questions are yet to be answered surrounding Bitcoin’s future as a currency and as a platform. The speculative and volatile nature of Bitcoin currency might be good for the short-term as it has generated tons of awareness in the mainstream media. However, will this volatility ultimately hurt the adoption of the overall Bitcoin platform in the long run? Bitcoin might only succeed if people start using it for daily transactions and a high volatility of the underlying currency would hurt that adoption.

Likewise, will heavy-handed regulation make it hard for Bitcoin start-ups to survive in the U.S. and will there be new Bitcoin ecosystems emerging outside of the Valley? We’ve already seen several new start-ups setting up shop in Canada to escape U.S. regulations, including the world’s first Bitcoin ATM in Vancouver.

I also wonder if the virtual/crypto currency space is a winner-takes-it-all market, or will we see many other alternatives emerge? Already today there’s Litecoin, Peercoin, and Primecoin, to name a few. Will we see numerous virtual currencies co-exist, perhaps segmented along geographical/regional or industry/markets? In a recent post, Simon Winder compared Bitcoin to Friendster – a first mover, but imperfect. The question then is, who will be MySpace, who will be Facebook?