PART 1 - The State Of Digital And Crypto Currencies In The 1990s:
Getting rid of fiat currency is a cornerstone idea of the modern cryptocurrency movement. Everyone knows that Peter Thiel made his money through traditional fintech, not crypto and that PayPal didn’t even support crypto until nearly 20 years after Thiel left the company. But, Thiel was actually far ahead of the curve in his understanding of how digital currencies would evolve.
In 1999, Thiel prophetically stated that the future of currency will,
Be something where you have a choice between different currencies, and the choice is not left to the sovereign but to the individual, and in a sense, the individual becomes sovereign and is able to make choices regarding which currency they want to take. - Peter Thiel
We are now seeing that exact prediction play out in crypto. Individuals are picking which currencies they think are most valuable, and sovereign governments are left out of the equation entirely.
But this raises two important questions. How was Thiel able to predict where financial technology was going so effectively, and why didn’t he create a cryptocurrency?
To answer these questions, we have to review the tumultuous history of internet money and walk through the challenges Thiel faced while building PayPal.
How Thiel First Found Cryptocurrency
One of Thiel’s favorite books is a 918-page sci-fi novel by Neal Stephenson titled Cryptonomicon. The main character of the book is a software engineer and cryptography enthusiast named Randy Waterhouse. While exploring a jungle in the Philippines, Waterhouse and his team discover a gold stash hidden there during World War 2. Waterhouse then creates a new decentralized digital currency backed by this gold stash. This idea is nothing new; after all, the U.S. dollar had been on the gold standard for decades before abandoning the system in 1971. But the decentralization aspect was new and would become remarkably important later on.
After reading Cryptonomicon, Thiel became fascinated with how digital currencies could be applied in real life. In 1997, a massive financial crisis hit Asia. Many countries, including Thailand, Malaysia, Indonesia, and the Philippines, were forced to devalue their local currencies. The citizens of these countries lost huge portions of their life savings, and if it could happen there, it could happen anywhere.
Thiel had the idea for a currency that people worldwide could store on their mobile phones, protected by a passcode. This would allow people in developing countries to avoid holding their savings in an unstable local currency.
I think that there are incredible technological forces pushing us in the direction of digital currency. - Peter Thiel
Even though he was one of the first entrepreneurs in Silicon Valley to push this idea, many other technologists had worked on this idea before. In 1990, a UCLA professor named David Chaum founded Digicash, which many consider to be the first cryptocurrency ever created. Digicash took money from a user's bank account and attached a private key to it. You could use the money only if you knew the private key, which in theory made it more secure than a traditional bank account. But the service never took off. After running a small-scale beta test with a regional bank in Missouri, the company shut down. The technology simply wasn't ready for mass adoption.
Literally, a couple of nights before I met Peter, I went to the shutdown party of DigiCash, which was on Stanford grounds, and it was a bankruptcy, the CEO brought in to dispense with employees and disposed of the intellectual property, it was really bad news. It was quite a number, and the whole concept of digital cash has been around for about 25 years. So certainly, we were not the first ones. - Max Levchin
PART 2 - PayPal And Cryptocurrency:
A few weeks after the Digicash shutdown, Thiel met then 23-year-old programmer Max Levchin. Levchin was basically the real-life version of Randy Waterhouse - he had just graduated from the University of Illinois at Urbana-Champaign and had experience building strong encryption software. Thiel and Levchin hit it off and soon agreed to found a company together.
I thought it made sense to try to get involved a little bit more in getting in one of these businesses started at the very beginning, and that fall, Max and I spent a lot of time brainstorming different ideas on different types of markets. Max wanted to do something with crypto, I have done a lot of work on encryption technology, I wanted to do something with finance and we finally decided that we wanted to try to do something with encrypted money on Palm Pilots; we thought this was going to be the future of the world and the two of us jointly started this company called Confinity, initially Feelink but renamed Confinity in December of 1998. - Peter Thiel
Their first product was a peer-to-peer money transfer service for the Palm Pilot. If you wanted to split a lunch bill, you opened the PayPal app on your Palm Pilot, picked an amount, and the money would reach your friend's Palm Pilot in five seconds.
To help make the service cryptographically secure, PayPal bought on Stanford professor Martin Hellman as a consultant and investor. Hellman was one of the inventors of public-key cryptography and had worked in the field for two decades already. Whether or not you realize it, you use public-key cryptography every single day. Every modern web browser uses it, and the American banking system uses it to process $4 trillion of transactions daily. Public key cryptography is also one of Bitcoin’s fundamental technologies. Were it not for Hellman, creating PayPal or Bitcoin would have been impossible.
Levchin believed that PayPal would change the world. Within a few years, everybody would be beaming money to each other on their Palm Pilots. Or at least that’s what he thought.
PayPal announced the service in July 1999 and received comprehensive media coverage. But they just couldn’t find enough users. There were only two million Palm Pilots users globally, and only a fraction of them had a real use case for this new money transfer service. So the PayPal team had no choice but to discontinue the Palm Pilot app.
Levchin’s idea to use public-key cryptography for transactions was solid. He had just chosen the wrong platform. When Bitcoin launched a decade later, it used many of the same cryptographic solutions as PayPal’s Palm Pilot app. But Bitcoin ran on a much wider selection of devices, which enabled it to spread more rapidly.
Paypal’s Pivot To Email
In September of 1999, three months after the Palm Pilot app, PayPal launched another service, this time targeted at a much wider market. The new payment service would enable users to send money to any email address anywhere in the world, which was a revolutionary concept at the time. Even though the email payment service was less polished than the Palm Pilot app, it quickly became popular. Timing is extremely important when launching a new technology, and 1999 was the perfect time to launch a new product that leveraged email. AOL alone had 20 million email users, more than ten times the size of the Palm Pilot market. And email adoption was growing at 60% per year!
At the end of 1999, the PayPal team analyzed their user data to find out why people were using the service. They were surprised that a large percentage of their users came from eBay. You see, back in 1999, many people paid for the things they bought online by cheque, which was slow, risky, and complicated. eBay users were desperate for a better alternative, which PayPal provided.
The internet is particularly great at cultivating many-to-many relationships. eBay connected millions of small merchants with millions of individual customers, and PayPal was able to solve a major problem by facilitating payment between these disparate parties. Interestingly, Bitcoin would also see growth a decade later thanks to Silk Road’s underground marketplace, which allowed people to buy items that couldn’t exactly be listed on eBay.
Paypal’s Marketing Strategy Sets An Example For Crypto
To encourage new sign-ups, PayPal offered $10 to every new customer and the person who invited them. This helped PayPal achieve growth rates of 7-10% per day, which is almost unheard of in the traditional marketing industry.
We've thought that it was a sort of, the viral marketing started in October, we launched on October 22, 1999, with 24 people in the office sending emails to other people. In the first month or two, it was slow. We were up to 1000 by mid-November, 12,000 by the end of December of '99. It grew by about 5% to 7%, compounding daily. It was 100,000 by February 2, 2000, and about a million by mid-April. The eBay subset was growing even faster. It was compounding about 7% to 10% a day. - Peter Thiel
In some sense, this viral marketing strategy is similar to how Bitcoin offers block rewards to its miners, which helped boost Bitcoin’s adoption, especially in the early years. And it’s no surprise that most crypto exchanges offer referral programs that are almost identical to the original PayPal program.
Peter Thiel And Elon Musk
A few months after PayPal started, Elon Musk’s internet bank X.com launched a similar email payments product, which also offered sign-up bonuses. By early 2000, both companies were in outright war, burning tens of millions of dollars per month. The X.com and PayPal offices were only a few blocks from each other in Downtown Palo Alto, which created intense competition.
Both companies realized that if they wanted to survive, they had to merge. After some quick negotiation, PayPal and X.com joined forces in a 50/50 merger in February 2000. The merger enabled them to reduce the sign-up bonuses and extend their runway.
But the company still didn’t have any actual revenue and every month had to pay millions of dollars in processing fees to Visa and Mastercard. To keep PayPal afloat, Peter Thiel went out to raise money. They closed a $100 million investment in March of 2000, which was perfect timing. A few weeks later, the Nasdaq tech index fell 9% in a single day, triggering the dot-com crash. Had PayPal not closed the funding round in time, they would have run out of money and gone bankrupt, like thousands of other Dot-com era startups. It’s unclear how much of this was luck, but it certainly worked out perfectly.
For the first few months after launching on eBay, PayPal faced little pushback from the auction site. But eBay was secretly plotting to push PayPal out. In March of 2000, the auction site launched its own payment service, Billpoint, in collaboration with Wells Fargo. To get users to switch from PayPal to Billpoint, eBay held promotional days during which Billpoint payments didn’t have any fees. eBay also restricted the size of the icons that third-party service providers like PayPal could embed on eBay’s website. When users reached the payment window, they were presented with an enormous Billpoint logo and a minuscule PayPal icon hidden next to it.
Fortunately, though, PayPal employees had one thing the Billpoint team didn’t have: the ability to iterate rapidly. If a PayPal engineer started coding an update on Monday morning, tens of thousands of customers would already be using it by Tuesday afternoon. By reacting fast, PayPal could fight back every time eBay came up with something to kill PayPal, allowing them to remain the most popular payment provider on eBay.
As PayPal scaled payment volumes, it faced a new problem: credit card fraud. Criminals, mostly in countries like Russia and Nigeria, used stolen credit card details to create PayPal accounts and siphon off the money. By the time PayPal detected the fraud and froze the account, the funds had already disappeared, and PayPal was on the hook to refund the victim. Visa and Mastercard threatened to stop supporting PayPal unless the company found a solution.
Anyway, we were bleeding something like 12 million a month in fraud in June 2000. That's in addition to things like referral bonuses and running the company and... We had to pay for some salaries, too. Yeah, salaries, too. So the burn rate was phenomenal and largely due to fraud. At that time, it became clear that we either figure out how to beat the fraudsters or the fraudsters will take us under. And the company more or less refocused itself as a research entity towards figuring out innovative technological ways of destroying fraud on the Internet. - Max Levchin
The issue was so dire that Max Levchin directed his entire focus to fight credit card fraudsters. To stop criminals from using software to create hundreds of accounts, Levchin and his team came up with the idea to require every new user to solve a simple puzzle. This was easy for a human but impossible for a computer. The puzzle later led to the creation of the modern-day CAPTCHA. In some ways, the CAPTCHA was a predecessor to Bitcoin proof-of-work. In both cases, users have to provide a small upfront commitment: for CAPTCHAs, it’s the time it takes to solve them; in the case of Bitcoin mining, it’s computation cycles. Both technologies ultimately increase the cost of bad actors manipulating the network.
In one funny story, Levchin started emailing with a Russian hacker named Igor, who was running one of the largest international fraud rings of the era. Igor boasted that Levchin could never stop him. In response, Levchin built a software program called ‘Igor’, which scanned through all transactions, looking for unusual usage patterns. The challenge that Igor issues clearly fueled Levchin to grind out a solution to the problem. And he succeeded! Within a few months, Levchin reduced fraud to less than half a percent of all transactions.
In general, every time a new technology emerges, there is bound to be at least some fraud. This was certainly the case for Bitcoin as well. Take Mt. Gox as an example. Mt. Gox was the first major cryptocurrency exchange, and at one point, it handled over 70% of all Bitcoin trading. But, Mt. Gox wasn't very secure; after all, it was originally a website where Magic the Gathering players could exchange cards. Because the Mt. Gox technology stack had been retrofitted so haphazardly, it had weak cybersecurity, which allowed 750,000 Bitcoins to be stolen from Mt. Gox in 2013. PayPal was focused on financial transactions from day one, so Levchin and his team built a strong tech stack resistant to cyberattacks.
By 2002, PayPal had over 8 million users and was processing $8 million per day across 150,000 transactions. The company had also reached profitability after it began charging users a transaction fee. Thiel and the executive team decided it was time for PayPal to go public.
There was one problem, though. Unlike the early days of Bitcoin, PayPal was subject to strict regulation. Only a few months before the IPO, the state of Louisiana requested PayPal cease providing their service in Louisiana until they received a money transfer license. Not long after, PayPal received a similar letter from the state of New York. Normally, this wouldn’t have been a big deal since Louisiana and New York made up only a few percent of PayPal’s overall business. But this was right before the IPO when the media was following PayPal’s every step. PayPal’s IPO was at risk of not happening.
But Thiel didn’t give up. Instead, he told the investment bankers to go forward with the IPO, no matter what. The plan worked. On Valentine’s Day 2002, PayPal IPOed on the NASDAQ, and everything went perfectly: the share price quickly climbed from $13 to over $20.
Paypal’s Acquisition: The End Of The Paypal Mafia
PayPal wouldn’t stay public for long, though. In July 2002, eBay made an offer to acquire PayPal for $1.5 billion. For years, the two companies had had a love-hate relationship. eBay needed PayPal because it was the most popular payment option on their platform. PayPal needed eBay because that’s where most of its customers were. The acquisition stopped the rivalry between the companies. But it also marked the end of PayPal’s startup culture. eBay’s bureaucratic management style quickly infiltrated PayPal, causing most of the founding team to leave soon after the acquisition.
Many of the early employees used the skills and the capital they had gained to start new companies. Peter Thiel started Palantir, Elon Musk started SpaceX and Tesla, Max Levchin started Affirm, Reid Hoffman started LinkedIn, software engineers Chad Hurley, Jawed Karim, and Steve Chen founded YouTube. The PayPal mafia, as they are now called, had a significant effect on Silicon Valley’s development. At a time when everyone else was still trying to recover from the dot-com crisis, PayPal and its alumni were doubling down and innovating faster than ever.
And this is an important takeaway. It can be counterintuitive, but oftentimes, the best time to start something new is during a crisis. It’s no coincidence that the Bitcoin whitepaper was published so soon after the Global Financial Crisis. So many people had lost hope in the established financial system. It was the perfect time to start something new.
Peter Thiel’s Impact On Cryptocurrency
But the story doesn’t end here. In 2010, Thiel announced the Thiel Fellowship, a $100,000 scholarship that enables university students to drop out and spend two years pursuing their ambitious projects. And one of the Thiel fellows in 2013 was Canadian software engineer Vitalik Buterin. The talented young hacker, introduced Bitcoin by his father, wanted to create a new cryptocurrency. That project became Ethereum, which is now the second-largest cryptocurrency in the world and is gradually delivering on Thiel’s original vision for digital currency.
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