The Bitcoin Economy Backbone – Bitstamp

On Friday, the U.S. Marshals are auctioning off nearly 30,000 bitcoin seized from the online drug bazaar Silk Road.

With Bitcoin worth close to $600 on most exchanges, that’s $17 million worth of Bitcoin on the table. Seen in a certain light, it’s bizarre that the feds are auctioning digital dollars. If they seized foreign currency in an IRL bust, they’d simply convert it to dollars and send it to the Department of Treasury.But they don’t have that option in this case. Regardless of the effect of trying to cash out $17 million worth of Bitcoin in one fell swoop when daily trading volume is just $14 million, the Marshals don’t have a U.

S.-federally-approved exchange to use.The few U.S. exchanges out there are only legal in some states. When it comes to turning significant amounts of Bitcoin into U.

S. dollars, all the action is in Europe.The top three BTC-USD exchanges are Bitstamp, Bitfinex and BTC-e, based in Slovenia & the U.K., and Bulgaria, respectively; they collectively see daily trading volume of 10,000 Bitcoin, or $6 million USD.

The exchanges have historically been regarded as mysterious and, well, weird. Slovenia? Yet even after Tokyo-based Mt. Gox’s crash-and-burn, serious Bitcoin businesses and traders can’t stay away from foreign exchanges; they still need digital money changers and the European exchanges are the main USD players.The three European exchanges have historically been press-shy. Bitfinex’s founder keeps his remarks to Reddit. The BTC-e crew has stayed anonymous while rumors swirl that they are actually based in Russia.

But the two twenty-something founders behind Bitstamp, Nejc Kodric and Damian Merlak, are increasingly opening up. They’ve attended Bitcoin events, collected a “best virtual currency startup” award at a European tech conference, and spent an hour with me on Skype talking about what it was like to discover Bitcoin and suddenly become two of the richest people in Slovenia.“We’re the backbone of the entire Bitcoin industry,” says Kodric, 25, who’s wearing a black t-shirt with “Zero Excuses” in fluorescent green capital letters. “The wallet services, ATM machines, mining companies all rely on us. The price of Bitcoin is the de facto price on Bitstamp.

We are the to-go exchange.”It may sound like bluster, but I hear the same thing when I talk to people in the wider Bitcoin community. Of all the exchanges, Bitstamp has 11% of the total Bitcoin market share in the last six months, and is at the top when it comes to US dollar trading.Kodric and Merlak, 28, live in Kranj, the fourth-largest city (population: 50,000) in the tiny country to the east of Italy.

“You could fit our whole population into Manhattan,” says Kodric, who sits in a sparsely decorated office there. He is the business brain on the team.Merlak, who wears a plain grey t-shirt and periodically pushes long dark bangs out of his eyes, is the financially-minded techie, having learned computer programming in primary school and dabbled in stock investing during high school. They’ve known each other since they were kids — which isn’t that long ago — because Merlak went to high school with Kodric’s older brother. Both are college drop-outs, lured away by profitable jobs.Merlak first started mining Bitcoin in 2011 while working as a software developer at Lyst after his boss mentioned it.

Kodric was in the business of selling computer hardware and started advising Merlak on the equipment he should use for the mining. “We started hanging out and drinking beers and talking about how cool Bitcoin was,” says Kodric.“We knew we wanted to go big on Bitcoin. Our original idea was to set up a mining pool but we knew there were people who knew way more about mining than us. Our next idea was to buy Bitcoin but it was hard to do as a European.

We had to wire money to Japan to Mt. Gox. That’s when we realized our best opportunity was to set up our own exchange.”Kodric describes the process of setting up the exchange at the end of 2011 as “pretty easy.” The Slovenian bank where they first opened a bank account didn’t object, as American banks did for regulatory reasons, having no idea what Bitcoin was.“We told them we were going to set up a platform to trade Bitcoin and they didn’t care,” he says.

“Being Slovenian and with media restricted to Slovenian news, people had no idea what Bitcoin was.” To be fair to Slovenia, I’d argue it was the same in the U.S.: Bitcoin did not really get on the mainstream radar here until 2013.

He says people started testing out the service and sharing feedback, and that its growth was a “snowball effect.” “Once you get liquidity,” he says, “you get more people.”Before Mt. Gox imploded, the exchange’s users were primarily European, but after its meltdown, it started picking up international clients and their registered users swelled to 350,000 people. To reassure the Bitcoin trading community that it won’t go Gox, Bitstamp has invited outside experts to confirm they hold the Bitcoin they’re supposed to hold.

Former Google engineer and Bitcoin developer Mike Hearn conducted the most recent “proof of reserves” check in May, confirming that Bitstamp had 183,000 Bitcoin in its wallet (or $110 million), which covered customer deposits, though he made clear it wasn’t a financial audit. The founders say they’re working on a true audit.Charging trading fees ranging from .5% to .2%, Bitstamp’s founders make clear in their steady, confident way that they are making bank, with monthly revenue between $700,000 and $900,000 USD. “We’re probably the richest 20-year-olds in Slovenia,” says Merlak.

Slovenia though is now well aware of the Bitcoin phenomenon. Kodric and Merlak were invited to meet with the president a few months back, who wanted to know how to keep start-ups from leaving the country.It didn’t work on Bitstamp. As the business grew over the last three years, the founders realized they didn’t have all the financial and legal services they needed in their home country.While all 24 of their full-time employees are based in Slovenia, they’ve outsourced support, compliance and legal needs to the U.K.

, which has helped them to institute all the screening “necessary to keep bad guys out” including proof of identity for both Bitcoin and fiat transactions.Bitstamp’s official business address is now in a London suburb. ”We fly to the UK a lot. Slovenia is not a financial capital in Europe,” says Kodric. “We are planning to relocate.

”When I ask them about their biggest challenges so far, they cite fear of expensive regulation and the Bitcoin malleability issue — a Bitcoin coding flaw that theoretically allowed users to falsify transactions, and which led to the exposure of Mt. Gox’s problems earlier this year. Bitstamp shut down for 48 hours to fix it.They are dismissive of the “51% attack” which has been in the news lately, a vulnerability in the architecture of Bitcoin which would allow a mining pool processing the majority of the transactions in the system to deceive the network long enough to benefit financially.

“If the 51% attack happens, then Bitcoin technology isn’t as stiff as we all thought it was, and it should die,” says Kodric. “We believe it’s not going to happen.”As for the Silk Road Bitcoin auction, they are not among the bidders — some of whose names were leaked by a Federal Marshals email ‘cc’ mistake.They make the obvious prediction that the Bitcoin will be sold for under-market value. They hope one day there is a compliant exchange the feds can use rather than selling off Bitcoin auction-style.

“Hopefully one day there will be others doing what we’re doing.”