How Peter Thiel Almost Created Bitcoin

Getting rid of fiat currency is a cornerstone idea of the modern cryptocurrency movement. We will get rid of currency in the fiat, conventional sense altogether, and it will be replaced. But everyone knows that Peter Thiel made his money through traditional Fintech, not crypto. PayPal didn't even start supporting crypto until nearly 20 years after Thiel left the company. But Thiel was actually way ahead of the curve in his understanding of how digital currencies would evolve. All the way back in 1999. Thiel Thiel said, it will be something where you have a choice between different currencies, and the choice is not left to the sovereign, but to the individual. We are now seeing that exact prediction play out in crypto. Individuals are essentially picking which currencies they think are most valuable, and sovereign governments are left out of the equation entirely. But this raises two important 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, as well as walk through the challenges Thiel faced while building PayPal. 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 II. Waterhouse then creates a new decentralized digital currency backed by this gold stash. This idea is really nothing new. After all, the US Dollar had been on the gold standard for decades before abandoning the system in 1971. But the decentralization aspect was new and would become really 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, and if it could happen there, it could really happen anywhere. Thiel had the idea for a currency that people all over the world could store on their mobile phone, 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. Even though he was one of the first entrepreneurs in Silicon Valley to really start pushing this idea, many other Technologists had worked on this idea before. In 1990, a UCLA professor founded Digicash, which many can consider to be the first cryptocurrency ever created. Digicash took money from a user's bank account and then attached a private key to it. You could use this 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. 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. Their first product was a peer to peer money transfer service for the PalmPilot. If you wanted to split a lunch bill, all you needed to do was open the PayPal app on your PalmPilot, pick an amount, and then the money would reach your friend's PalmPilot in five seconds. To help make the service cryptographically secure, PayPal brought on Stanford professor Martin Hellman as a consultant and and an investor. Hellman was one of the inventors of public key cryptography and had been working in the field for two decades already. What public key cryptography allows us to do is I tell him the protocol, you hear it too. We then do some calculations and create some random numbers, each of us, and at the end, he and I have exchanged information that you cannot understand. Whether or not you realize it. You use public key cryptography every single day. Every modern web browser uses 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. Everyone 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 of 1999 and received wide media coverage. But they just couldn't find find enough users. There were only 2 million people with PalmPilots globally, and only a fraction of those people actually had a real use for this new money transfer Service. So the PayPal team had no choice but to discontinue the PalmPilot app. Levchin's idea to use public key cryptography for transactions was solid, though he had just chosen the wrong platform. When Bitcoin launched a decade later, it used many of the same cryptographic solutions as PayPal's PalmPilot app. But Bitcoin could run on pretty much any device, which enabled it to spread much more rapidly. In September of 1999, three months after the PalmPilot 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 in the world, which was a revolutionary concept at the time. Even though the email payment service wasn't as polished as the PalmPilot app, it quickly became popular. Timing is extremely important when you're 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 10 times the size of the PalmPilot 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.

January 2000, people from eBay started sending us emails saying hey, could we have a permission to include your logo in our auction?

You see, back in 1999, many people paid for the things that they bought online using check, 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, a decade later, bitcoin would also see growth thanks to the the underground marketplace Silk Road, which allowed people to buy things that couldn't exactly be listed on ebay. To Encourage new signups, PayPal offered $10 to every new customer and the person who invited them. This helped PayPal achieve growth rates of 7 to 10% per day, which is almost unheard of in the tech industry.

This was touted as the most insane scheme of all times. Of course, the one thing that these people didn't really calculate is that the average cost per Customer was then $20. The nearest average cost of customer acquisition was higher.

75 to 100 was the next cheapest alternative. In some sense, this viral marketing strategy is similar to how Bitcoin offers block rewards to its miners. And it's no surprise that most Crypto exchanges now offer referral programs that are almost exactly identical to the original PayPal program. A few months after PayPal started, Elon Musk's Internet bank X.com launched a similar email payments product which also offered signup bonuses. By early 2000, both companies were in an outright war, burning tens of millions of dollars per month. The X.com and PayPal offices were only a few blocks away from each other in downtown Palo Alto, which created intense competition.

How much did one of them spend with that kind of 5, 10, $20 incentive to get that critical mass going? It was a fair amount. I think it was probably 60 or $70 million.

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 5050 merger in February of 2000. The merger enabled them to reduce the sign up bonuses and extend their Runway. But the company still didn't have any real 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. Just a few weeks later, The Nasdaq fell 9% in a single day, triggering the start of the.com crash. Had PayPal not close the funding round in time, they probably would have run out of money and gone bankrupt like thousands of other dot com era startups. 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. EBay's website when a user reached the payment window, they were presented with an enormous BillPoint logo and a miniscule PayPal icon hidden next to it. Fortunately though, PayPal employees had one thing that the BillPoint team didn't the ability to iterate rapidly. If a PayPal engineer started coding an update on Monday morning, then by Tuesday afternoon, tens of thousands of customers would already be using it. By reacting quickly, PayPal could fight back every time eBay came up with something to kill PayPal, allowing them to remain the most popular payment provider provider on eBay. As PayPal scaled up their Payment volumes, they faced a new credit card fraud. These criminals would use stolen credit card details to create PayPal accounts and then siphon off the money. By the time PayPal detected the fraud and froze the account, these 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. The issue was so dire that Max Levchin directed his entire focus to fighting credit card fraudsters. In order to stop criminals from programmatically creating hundreds of new 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's proof of work. In both cases, users have to provide a small upfront commitment. For captchas, it's the time that it takes to solve them. And in the case of bitcoin mining, it's the computational cycles. Both technologies ultimately increase the cost of bad actors manipulating the network. In one funny story, Levchin actually started emailing with a Russian hacker named Igor who was running one of the biggest fraud rings at the time. 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 had issued 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 of a percent on all transactions.

We brought it down by the end of 2000 to about 55 basis points, which is 0.55%. Average losses online at the time were averaging about 1%. At the end of 2001, we were at about 0.37.

In general, every time a new technology emerges, emerges, there is bound to be at least some fraud. This was certainly the case for Bitcoin as well. Take Mount Gox as an example. Mount Gox was the first major cryptocurrency exchange, and at one point, it handled over 70% of all bitcoin trading. But Mount Gox wasn't very secure. After all, it was originally a website where 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 that was 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 small transaction fee. These were some really solid milestones. So 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 that PayPal cease providing their service in Louisiana until they received a money transfer license. Not long after that, 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 only made up a few percent of the 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 IPO'd on the NASDAQ and everything went perfectly. The share price quickly climbed from $13 to over $20. PayPal wouldn't stay public to for long, though. In July 2002, eBay made an offer to acquire PayPal for $1.5 billion. For years, the two companies had been in 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 a firm, Reid Hoffman started LinkedIn, and a group of software engineers created 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 a really 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 white paper 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. 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 most ambitious ideas. And one of the thiel fellows in 2013 was Canadian software engineer Vitalik Buterin. The talented young hacker had been introduced to Bitcoin by his father and 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. But. But that's a story for another time. Thanks for watching.