SecondMarket CEO explains Bitcoin bet, and why his firm still has swagger

SecondMarket, a company that connects buyers and sellers over esoteric investments, raised eyebrows last month when it announced its latest opportunity: a private fund for buyers of the virtual currency, Bitcoin.

Financial blogger Felix Salmon was not impressed, declaring that the fund was new evidence of a “whiff of desperation.” The criticism comes as SecondMarket, which made a bundle slinging private Facebook shares in 2011, has pin-balled from product to product — everything from wine to diamonds — in an attempt to find a follow-up hit.

CEO Barry Silbert doesn’t appear fazed, however. During an interview at SecondMarket’s New York office, he explained why the economic and political stars are aligning for Bitcoin, and how his company plans to be a permanent part of the growing world of angel investing.

Why Bitcoin is in a sweet spot (even after Silk Road)

SecondMarket’s decision to launch the Bitcoin Investment Trust, which offers shares backed by Bitcoin to private investors, presents skeptics with two obvious objections: first, Bitcoin is too damn sketchy. Second, even if it isn’t, why would people buy it from SecondMarket? The first claim is the easier one for Silbert to rebut.

In Silbert’s view, the regulatory clouds around Bitcoin are clearing. He says the currency is gaining legal legitimacy and finding allies in Washington from across the political spectrum — including libertarians who like the idea of a currency that’s not tethered to a central bank, and liberals who see Bitcoin as a way for consumers to escape high banking fees.

“If you have something where Rand Paul and Liz Warren are in agreement on the same policy, that’s a good place to be politically,” said Silbert.

He adds that law enforcement and financial agencies are becoming more familiar with Bitcoin, and that the IRS will soon sort out tax implications since every transaction is recorded in the block chain (a central ledger that records Bitcoin transactions).

The CEO, a former Wall Street man, also remains bullish despite last week’s dramatic FBI takedown of Silk Road, a giant online bazaar for drugs and crime services where users paid with Bitcoin. The currency plunged on news of the raid but nearly recovered by end of day.

“It is encouraging that the FBI emphasized in the criminal complaint that Bitcoin is legal and used for legitimate purposes.  In fact, more than 10,000 merchants now accept Bitcoin.  I don’t see this action having any significant effect on the near or long term prospects for Bitcoin adoption worldwide,” said Silbert.

Silbert also believes that Bitcoin is a “fantastic remittance tool,” that could undercut companies like Western Union, which charge fees around 9% for workers to wire money home to their families (LemonWallet’s Wences Casares has made the same argument). The first big Bitcoin remittance axis, he predicts, will spring up between the United States and India.

Room for a middleman?

Silbert makes a good case for Bitcoin believers, but there’s still the question of why investors would buy a fund from SecondMarket — and not just buy the stuff directly, especially since US-based outfits like CoinBase are making it easier to buy larger quantities on a daily basis.

And, as the blogger Salmon notes, the transaction costs involved with the Bitcoin Investment Trust are significant:

“You still have to pay a fee of 2% per year to SecondMarket for all the work they’re doing sitting on your bitcoins. And then, if you ever do decide to sell, you have to pay another 1.5% fee to get out. On top of that, if you buy into the trust after January 1, you’re also going to have to pay a 1.5% fee to get in.”

Salmon adds that holding Bitcoins through SecondMarket makes them an even more illiquid investment than they are already and, with the fees, a 30-year investment would result in 47% of the proceeds going to the company. But Silbert says this misses the point

“I understand his point and his math but if the price goes up 10 times tomorrow, you’d still pay only 2 percent.. It’s not a two-and-twenty fund.”

Silbert also makes the case that selling Bitcoins in the form of securities will make them available to funds and other institutions whose charters limits them to traditional investments.  Likewise, he says, the product will allow people to put Bitcoins into things like IRA’s or family trusts (this last idea is intriguing — does anyone people believe in Bitcoin enough to bet part of their retirement or their kids’ future?).

SecondMarket also says the Trust is a good bet because it enjoys relationships with 100 Bitcoin sources around the world — miners, exchanges and more. That broad sourcing, says Silbert, means it can provide large quantities to investors at a predictable price. But if the Bitcoin bet doesn’t pay off, what then?

Send me an angel

In 2011, reports gave SecondMarket a valuation of $200 million on annual revenue of $35 million. These figures, however, were driven in large part by a single company — Facebook(s fb), which let employees and investors trade shares at weekly SecondMarket auctions prior to the company’s IPO.

SecondMarket  earned commissions on the trades that accounted for a third of its revenue, according to a Bloomberg report, but the company has since been unable to find a similar cash cow. It has not brokered a single private trade this year for Twitter, which could be 2013’s hottest IPO.

“Facebook was a very unique situation given the size of the company and the unprecedented interest in Facebook stock. We will not replicate the revenue lost from Facebook by facilitating transactions in any single company,” said a company spokesman. It would not say if it has since matched the reported $35 million it earned in 2011.

Silbert noted that Facebook-like opportunities are harder to come these days by since companies now exercise much more control over how their private stock is traded. But while SecondMarket is unlikely to enjoy another big bonanza like Facebook, it is still a forum for investors looking to get their hands on stock for companies like Evernote, Dropbox and Survey Money.

In the long term, though, SecondMarket’s best hope may be to make up the lost Facebook business through volume, a task that will be easier thanks to the JOBS Act, a law that loosens regulations on how start-ups can advertise and sell shares.

For SecondMarket, the opportunity lies in the fact that the Jobs Act now allows equity crowd-funding, which means groups of smaller angel investors can band together through services like AngelList. This new rule transforms the fund-raising landscape, but also the compliance one; now, start-ups and angels need a service that can quickly verify that an investor in fact qualifies as “accredited” — a service that SecondMarket can provide.

Silbert explained that his company charges $250 to $400 to verify an investor, and that the service is appealing to angels and other investors who don’t want to share their financials with start-ups. The company is also creating a national database of accredited inventors, and supplying “multiple products” to AngelList; the company’s list of other “products” include communications and notification tools.

The bottom line here is that SecondMarket’s days offering glamorous investments — including private Facebook shares, wine and Bitcoin — could be numbered. The company may, however, have a bright business future if it doesn’t mind pivoting full-time into dull but steady backend services.