Encore: Crypto Wars | Block Busting | 4

0:00This series originally aired in 2021.

0:12January 2015, San Francisco. It's almost 6 a.m. In Coinbase's office, there's a pajama party going on. Employees and PJs crowd around a screen fixed onto the wall. On the screen is a countdown, and there's less than five minutes to go. At a desk at the opposite end of the room is CEO Brian Armstrong. He lifts his headphones off his bald scalp and stretches. It's almost showtime. Coinbase is about to launch its new Bitcoin exchange. Armstrong is sure it'll be a game changer. American Bitcoin investors will finally have a homegrown exchange that takes security and regulation seriously. They won't have to send money to shady offshore websites anymore.

1:01Armstrong stands up to join the team. As he walks over, co-founder Fred Ursim joins him. Ursim buzzes around him high on excitement and energy drinks. Ha! This is it, Brian. All the Winklevosses have is talk. We've got an actual exchange, and it's ready to go. Armstrong frowns. He's trying to forget about the Winklevoss twins. Two days ago, the twins announced their return to the Bitcoin battlefield with Gemini. It's also going to be a U.S.-licensed exchange, and a direct rival to Coinbase's new Bitcoin marketplace. Gemini is still months away from launch, but the twins' celebrities snatch the media spotlight away from Coinbase's big day.

1:46Armstrong turns to Ersim. Are you going to get the pep talk? Of course. Ersim gets the team's attention. Hey everyone, are you ready? The sleepy team murmurs. Ersim scowls. Oh no, I need more than that. We're about to launch America's first licensed Bitcoin exchange. The first. You people did that. We'll take Bitcoin out of the shadows, make all those shaky exchanges out there history. So I ask you again, are you ready? Yeah! Good. Now let's get this thing live. The team chants the final seconds of the on-screen countdown out loud. The countdown on the screen vanishes, replaced by the now live Coinbase Exchange website.

2:40Armstrong smiles as his team cheers, hugs, and high-fives. But he's already thinking of the battle ahead. he knows the next few months will be critical. Coinbase needed this head start over the Winklevoss twins to gain maximum ground. But it's about to fumble the ball.

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5:18On the last episode, the Winklevoss twins' investment in BitInstant went up in smoke after regulatory failures forced the company offline and leading Bitcoin exchange Mt. Gox collapsed after hackers stole its customers' Bitcoins. It was a costly lesson for Bitcoin investors, but the Winklevoss brothers are not running away. They sense a new opportunity to win, and win big, by offering Americans a secure, regulated place to buy and sell Bitcoins. Now, both the Winklevoss twins and Coinbase are racing to position themselves as the safest place to trade Bitcoin. But Coinbase is about to find the barons of high finance have little patience with Silicon Valley's culture of flouting the rules.

6:09This is Episode 4, Blockbusting.

6:22February 2015, Disneyland, California. Coinbase Compliance Chief Martine Neadlet strolls through Frontierland past the Mark Twain Riverboat towards the Red Rocks of Big Thunder Mountain roller coaster. It's her birthday, and she wants today's visit to the Magic Kingdom to take her mind off the battles at work. She joined Coinbase 18 months ago. Her job is to keep the crypto startup on the straight and narrow by making sure the company follows state and federal regulations. It's a task that means she's constantly clashing with Coinbase's co-founders, Brian Armstrong and Fred Urson, over what the company can and can't do.

7:05They want regulators' approval, but they don't want to be held back by paperwork and procedures. She checks her paper map of the park, trying to work out where to go next. As she gets her bearings, her phone rings. It's Ursa. Ugh, really? Fred, I'm at Disneyland, on vacation. Can't this wait? Sorry, no. We have a problem with the exchange. All right, hit me. The California Department of Business Oversight just issued a customer alert about us. Njadlik frowns. California's financial regulator doesn't deliver public smackdowns without reason. She moves to get out of the path of passing families and finds herself overlooking one of the theme park's artificial lakes.

7:54And why did they do that? I may have misspoke in an interview. I said the Coinbase exchange is licensed in California. Why? Why did you say that? California is still on the fence about whether its laws apply to virtual currencies. I also mentioned New York. Yadlik resists the urge to hurl her phone into the water. Fred, how are we supposed to win regulators' trust if you pull stuff like this? Well, you know how it is in a startup. Move fast, break stuff, ask for forgiveness afterwards. No, no! That doesn't fly with finance. Finance is extensively regulated. You don't get a free pass just because you think you deserve one.

8:38Sure. Okay, anyway, what should we do? Put out a clarification. I'll try to smooth things over with the regulators when I get back. Great. Oh yeah, and happy birthday too. It's an embarrassing start for the Coinbase exchange. It's barely a month old, but it's already getting slaps on the wrist from state regulators. And there's even bigger trouble on the way.

9:09February 2015, Santa Clara, California. In the headquarters of Silicon Valley Bank, the legal team is holding its regular risk review. And one customer is dominating the discussions. Coinbase. A young lawyer plugs his laptop into the projector and brings up a news story from the Washington Free Beacon website. The headline reads, Bitcoin exchange highlights to investors currency's ability to evade sanctions. The lawyer turns to his colleagues. So, the beacon got hold of this presentation Coinbase was using to raise investment late last year. And in its presentation, Coinbase was basically highlighting to investors how Bitcoin can be used to bust sanctions against countries like Russia and Iran.

9:57The lawyers in the room take a moment to digest this. One of the team members breaks the silence. Did Coinbase respond to the story? Yeah. They said the lack of government controls is one of the most revolutionary aspects of Bitcoin. A senior lawyer with wireframe glasses shakes his head. Not good enough. Well, I suppose they're just stating a fact about Bitcoin. They're not actually endorsing breaking sanctions. Even so, we can't ignore this. Coinbase is a high-risk customer for us. They operate in a legal gray zone, and they've just had a public bust-up with the regulators in New York and California.

10:39Look, in my view, they're just too hot to handle. But isn't that what Silicon Valley Bank is all about? We're here to offer banking services to startups with unorthodox and risky business models. Coinbase fits the bill. Yeah, there's risk, and there's risk. No other bank in America wants to touch these fast-and-loose crypto companies. They're not willing to risk the regulatory heat these firms' activities could bring. And the stuff they might do, you know, it might be okay in London or Singapore or Moscow, but not here. We need to legally protect ourselves. I say we drop them. Immediately. Whoa.

11:15Without a bank, they can't function. If we do it without notice, we're effectively shutting them down. At least give them six months to find a new bank. The senior lawyer nods. Hmm. I suppose you're right. They do have some major investors behind them. Wouldn't be good to annoy them. Okay. Six months, but not a day more. Closing the books, getting your people paid, and bringing on new hires. Running a small or mid-sized business can be exciting, and also a little chaotic. Workday Go makes simplifying your business, well, simple. Imagine all the important aspects of your company, HR, finance, and payroll, all on the AI platform.

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13:24Pacific Life Insurance Company, Omaha, Nebraska, and in New York, Pacific Life & Annuity, Phoenix, Arizona. Because with Pacific Life, you're not just planning for the future, you're partnering with trusted experience. The next day, Silicon Valley Bank delivers the bad news. It's a hammer blow that threatens to destroy Coinbase. Without a U.S. bank, Coinbase will no longer be able to serve U.S. customers, and its image as a safe haven in the sketchy world of crypto will get obliterated. Coinbase scrambles to find a new bank, but time after time, banks slam their doors in the company's face. America's banks want nothing to do with the legally murky and unpredictable world of Bitcoin.

14:16As Coinbase races to find a new bank, the Winklevoss twins are building the hype around their soon-to-launch rival, Gemini. It's March 2015. In Austin, Texas, the South by Southwest Festival is underway. Backstage at the Austin Convention Center, Tyler and Cameron Winklevoss clip transmitters to their belts and thread their lapel mics up inside of their untucked shirts. They're here to spread the word about Gemini, their new Bitcoin exchange. They hope a warm reception here will catapult them back into the action. Since the collapse of BitInstant and the arrest of its founder, Charlie Schramm, the twins have been plotting a comeback.

15:02They've poached some of Wall Street's best to help them build what they hope will be the NASDAQ of Bitcoin. But doing that means going head-to-head with Coinbase. The conference floor manager races over, clipboard in hand. Okay, we're ready for you guys. Come, follow me. The twins follow the woman to the stage entrance and enter the room. Hello, everybody. Say hi to Cameron and Tyler Wickelthaus. Thank you, Eric. Why don't you tell people what Gemini is and what you hope to do? So Gemini is a place to buy and sell Bitcoin. We're New York-based. We're New York headquartered. We're U.S. banked. Your money never leaves the shore.

15:44We take compliance to the utmost degree. And Cameron, how does it differ from Coinbase? Well, so we're not currently operational. We're waiting to be licensed and regulated. Coinbase operates a spot exchange. But we've sort of taken the approach that we don't want to sort of service customers until we have that license, for better or worse. We're asking for permission before forgiveness. The twins' plan to wait for regulatory approval is a sharp contrast from Coinbase. Gemini and Coinbase both want to be seen as the trustworthy choice in crypto. But their tactics stand apart. While the twins are waiting for regulators to catch up with crypto, Coinbase is pushing forward and hoping regulators will forgive it if it pushes its luck too far.

16:37But the twins don't have to wait too long to start getting the okay from state regulators. In October 2015, New York's state regulator greenlights Gemini, and it opens for business, piling fresh pressure on Coinbase.

16:57Late 2015. In a hotel conference room in San Francisco, the Coinbase board is meeting, and its members are not happy. One board member fixes his eyes on Brian Armstrong and presses the Coinbase CEO to change course. Don't dismiss a pivot out of hand. YouTube started as a video dating site, you know. Twitter was a podcast network. Pivoting isn't a failure. Armstrong purses his lips as another board member joins in. Bitcoin's been in a price rut all year. Coinbase's growth is slowing. Your revenue is flatlining. Forget about crypto and do something else. IBM and Microsoft are exploring how to use blockchains in enterprise software.

17:42Coinbase could apply its skills in that arena. You could pivot into creating tamper-proof corporate databases. Armstrong frowns. Look, I didn't start Coinbase to build corporate databases. I did it to take Bitcoin mainstream. Oh, please, Brian, your engineers are quitting to join more promising startups. You lost your bank earlier this year. Who's to say that your new bank won't drop you tomorrow? You still have cash. Pivot now while you still can. Armstrong locks eyes with the board member. We are not pivoting. We built up a two-year cash cushion so we can ride out times like these. Bitcoin will rebound.

18:24Brian, you know, when I joined this board, you were talking about people using Bitcoins like cash. Whatever happened to that? People do not use Bitcoin like cash. They treat it like gold. It's an asset they hope will grow in value, not money to buy coffee with. It's too volatile. The price of Bitcoin can change drastically in the time it takes me to walk to a Starbucks. And the Bitcoin network is slow. Visa and MasterCard processes thousands of transactions a second. Bitcoin does, what, seven? My point here is, Brian, you were wrong about Bitcoin replacing cash. And you know, you could be wrong again.

19:03Armstrong nods. Yes, that's true right now. But the payment processing problem is solvable. The code behind the Bitcoin network can be changed to make payments faster, and I intend to make that happen. But Armstrong's new quest to change the code and accelerate Bitcoin payments won't be easy. Bitcoin's code is maintained by a small team of volunteer developers who refuse to stray from Satoshi Nakamoto's original vision for the currency. Armstrong's only hope is to find a way to bypass these self-appointed gatekeepers.

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20:42The End behind. They're here to settle a fight that's been ripping the Bitcoin world apart. A fight over how big a block on the blockchain should be. The blockchain is the permanent public record of every Bitcoin transaction ever made, and it's built out of blocks of data. Armstrong and his supporters want bigger blocks. That's because bigger blocks hold more transaction data, and since new blocks only get added to the blockchain every 10 minutes. More data in each block means Bitcoin payments will get processed faster. But not everyone thinks bigger is better. Bigger blocks require more computer processing power to make and favors institutions over individuals.

21:35And that betrays Satoshi Nakamoto's original vision of Bitcoin empowering people over organizations. Right now, the small block faction is winning. The cabal of developers who maintain Bitcoin's code are dead set against big blocks. And what these high priests of crypto say usually goes. But Armstrong's got a plan to yank the rug out from under them. Armstrong and the American delegation enter one of the hotel's meeting rooms. Inside, sitting around a table covered with black cloth, are the Chinese Bitcoin barons he needs to charm. When Nakamoto started the Bitcoin network seven years ago, even the puniest laptop could connect to it and stand a good chance of earning Bitcoin for its owner.

22:27Not anymore. These days, most new Bitcoins are won by specialized Bitcoin mining computers housed in giant server farms. The mining computers in these farms do nothing but solve the math puzzles needed to earn Bitcoin. And that means normal PCs just can't compete. But these Bitcoin mining computers need lots of power. So most of these facilities are now found in China, where there's plenty of cheap electricity to tap into. The men in this room represent the four biggest Bitcoin mining groups in China. Together, they control 70 % of the computers on the global Bitcoin network. They politely welcome their American visitors before inviting Armstrong to make his case.

23:15Small blocks are a bottleneck in Bitcoin's design. The time it takes for payments to be processed is getting longer. Bitcoin's very future is at stake. For better or for worse, you have leadership in the Bitcoin industry. Everyone is looking to you to show that leadership. Together, you control the majority of computers on the Bitcoin network. You have the power to change the code and introduce bigger blocks. One of the Chinese miners interjects. Our expertise isn't hardware. Why are you asking us to make software decisions? The status quo works well for us. Why should we jeopardize that? Armstrong smiles.

23:56I think you've been misled. You've probably been told that only the inner circle of Bitcoin developers can modify the code. That's not true. We actually don't need them at all. The code is open source, which means no one controls it. We can change the code to add the bigger blocks that will ensure Bitcoin's future success. Believe me, as CEO of America's biggest Bitcoin company, I know this change is vital. The Chinese miners exchange glances. Armstrong has severely misjudged his audience. Coinbase might be the biggest crypto exchange in the U.S., but compared to China's exchanges, it's a minnow.

24:39More than 33 million bitcoins are traded on China's top exchange every month. Coinbase users trade less than a quarter of a million a month. To these Chinese power players, Armstrong is coming over like an arrogant American who thinks Silicon Valley leads the way in crypto. But they know the reality. In the business of crypto, the U.S. lags behind. American Bitcoin startups are still trying to navigate their nation's bureaucratic maze of state and federal financial regulators. In China, the communist regime seems, at least for now, indifferent to crypto companies, even if they bend the rules. The Chinese miners confer for a few moments.

25:26Eventually, the boss of the world's most powerful Bitcoin mining group turns to Armstrong. Mr. Armstrong, we do not agree that there is a need for change at this moment. Armstrong senses the chance to turbocharge Bitcoin payments, slipping through his fingers. But the time it will take to process payments will keep rising if we don't do this. Bitcoin's viability as a currency will be in danger. Mr. Armstrong, in China, people see Bitcoin as a speculative asset. They don't buy things with Bitcoin. They buy Bitcoin hoping it will go up in value. Besides, delays in payment processing might be good for us miners.

26:08We might be able to charge people who want their transactions processed faster. Armstrong's shoulders sag. He's lost the argument. He leaves the room, heartbroken. He started Coinbase as a digital wallet service, hoping to usher in a future where people pay for everyday transactions in bitcoins instead of dollars. He imagined Coinbase becoming the Visa and MasterCard of the crypto age. But now, that future seems lost. The Bitcoin community has made its decision. Bitcoin's transaction processing bottleneck isn't going away anytime soon. But Bitcoin's no longer the only game in town. A new cryptocurrency created by a teenager with a taste for My Little Pony t-shirts is about to go supernova.

27:05It's called Ethereum, and it's about to ignite a crypto stampede that'll make investors easy prey for scammers. On the next episode, a 19-year-old genius reinvents the blockchain, Gemini gets the jump on Coinbase, and a Chinese startup goes from zero to hero.

27:34From Wondery, this is Episode 4 of Crypto Wars for Business Wars. A quick note about recreations you've been hearing. In most cases, we can't know exactly what was said. Those scenes are dramatizations, but they're based on historical research. Now, if you'd like to learn more about the Coinbase story, we recommend the book Kings of Crypto by Jeff John Roberts. I'm your host, David Brown. Tristan Donovan wrote this story. Voice acting by Michelle Phillippe. Karen Lowe is our senior producer and editor. Edited and produced by Emily Frost. Sound design by Kyle Randall. Our producer is Dave Schilling.