Hummingbird Ventures

Kraken is a young, San Francisco-based bitcoin exchange that last year stepped in to help return money to customers of the bitcoin exchange Mt. Gox after it abruptly shut down. Now Kraken, known for its cautious approach around regulations, is navigating the vicissitudes of the bitcoin market in the hope of keeping its own doors open for many years to come.

One of the challenges it’s facing is U.S. authorities, who’ve long struggled to understand bitcoin and have yet to figure out exactly how to regulate it. California and New York, for example, are still in the midst of passing virtual currency-specific licensing requirements, rules that many thought would be finalized by now. Like other bitcoin companies, Kraken has also seen many formerly bullish investors turn weary now that it’s apparent bitcoin’s story will take longer than imagined to unfold.

We recently chatted with Kraken founder and CEO Jesse Powell about what a bitcoin entrepreneur is to do in the current market. Our chat has been edited for length.

Who is using your exchange?

We have clients in more than 130 countries, but our customers are mostly Europeans. With have a partnership with Fidor Bank in Germany, and it can receive and make same-day payments within the eurozone for 9 cents, which is kind of hard to beat. That relationship has allowed us to flourish in Europe.

Are those mostly wealthy Europeans? What’s the use case?

There are certainly some wealthy people using the exchange, but it’s more like middle-to-upper class Europeans who are using bitcoin and trading bitcoin. It’s a bit of a luxury item; people who are trading hopefully have some discretionary income. It’s still a risky asset to be playing with, so I expect most [users] aren’t living paycheck to paycheck.

Do you have any partnerships with U.S. banks?

We don’t operate in the U.S. because the regulatory situation is much more open abroad and we have regulatory coverage there. Unlike virtually every other bitcoin business, we’ve chosen not to operate here until we have the licenses required. Competitively, that’s difficult, because other services are serving U.S. clients. Whether they’ll pay the price in the long run, we’ll see, but they’re exposing their companies and investors to huge liabilities. It’s not a risk we’re comfortable taking.

[Editor’s note: After our chat, Kraken announced that it has hired a chief compliance officer to help it prepare for regulatory changes in the U.S. and elsewhere.]

What kind of feedback have you been receiving from investors? Do you gather they’ve run out of patience already?

In some cases. You have to be a believer in bitcoin. We don’t know when bitcoin is going to become a success or what that will look like, but if you believe it’s inevitably going to happen – as we do – it’s a good time to get in. If the price goes to $1,000 again or hits $10,000, some companies, including ours, won’t need investment [because they’ll be collecting much more off each trade], and they’ll be worth far more. A client base of 100,000 users today could be 100,000 millionaires when the price of bitcoin increases tenfold.

What about other digital currencies? We talked about a year ago and you seemed unconvinced that bitcoin would be the undisputed king.

Most of those [other digital] currencies have lost a tremendous amount of value and I don’t see any of them regaining traction.

Does this feel like an early tipping point for the industry?

There’s definitely some consolidation happening right now. We’ve seen some exchanges fold recently. It’s getting to be a problem for the smaller players, especially in a down market, where bitcoin has been relatively flat for the last six months. That’s definitely had an effect on a lot of business [whose customers] might have chosen to speculate on bitcoin. Also, because the price is down [trading at roughly $230, from a 2013 peak of $1,240 per bitcoin], if you’re taking a percentage of each transaction as a fee, you’re taking in less revenue. Meanwhile, the infrastructure required to maintain an exchange or a wallet is high. There are very few businesses that are actually profitable right now, other than those who’ve done no compliance or shown little consideration of the regulatory requirements.

Why do you think some startups are operating without the regulatory requirements?

Maybe they’ve received special off-the-record exceptions through the right connections. It’s kind of like, ‘We’ll look the other way until we figure out what we want to do.’

From a distance, venture capital in Turkey and the broader Middle East seems to be taking off. Among other things, in December, a Dubai-based investing duo announced they were forming a new, early-stage venture capital firm called Emerge Ventures to focus on Middle East startups. In January, renowned angel investor and entrepreneur Fadi Ghadour disclosed plans to launch a new venture fund to support startups in the Middle East and North Africa. And Earlybird Venture Capital, the 17-year-old, Berlin-based early-stage venture firm, announced that it’s raising a fund to focus on companies in Turkey and Central and Eastern Europe. (It has closed on $110 million so far; it’s targeting $130 million.)

To get a better sense of what’s going on, StrictlyVC talked with Pamir Gelenbe, a venture partner with Hummingbird Ventures, a young, early-stage firm with offices in London, Antwerp, and Instanbul. Among the firm’s investments are Turkish game developer Peak Games, which has raised $18 million to date; and the invite-only shopping site MarkaVIP, which is based in Amman, Jordan, and has raised $15 million.

So what’s happening in the Middle East? Why is there more activity suddenly?

I don’t think there’s been any sudden step change. In fact, we’re excited about that part of the of world because we pretty much have no competition. There are a few funds (including recent entrant Doğa Ventures, founded in late 2012 by famous Turkish businessman Fethi Şimşek). But the competitive intensity in the Bay Area is probably one hundred times what we’re facing.

Are you seeing much innovation? And how’s your deal flow?

It’s okay, but you have to be patient. Some startups copy earlier successful models. A few have developed something truly innovative, and we advise them to move their headquarters to the Bay Area to develop their go-to-market approach and maybe to get acquired, because that isn’t going to happen if you’re sitting in Turkey or the Middle East.

In the grand scheme of things, the scene is pretty small, but entrepreneurship is definitely on everybody’s mind. In Turkey, there are probably two or three entrepreneurship conferences every week. It’s become a big thing. And there are maybe a dozen local VCs in Turkey who are serious and another dozen external VCs who are looking on a regular basis.

What about the rest of the Middle East?

Halve those numbers. The Middle East is very fragmented; it’s 20 countries or so, so unless you’re in digital media, where regulation is immaterial as long as you don’t show profane pictures, you’re fine. But if you’re dealing with e-commerce, you’re dealing with customs and every state’s regulations, and it becomes pretty hard.

In Turkey, e-commerce was really hot then cooled somewhat. Why?

Turkey has a strong logistics network, with the largest fleet of trucks in Europe and very good roads that cover the whole country. It also has a great payments infrastructure. It’s much better than in the U.K., where until recently, you couldn’t send instant transfers between banks but had to wait two days instead. [Turkey] has just leapfrogged all this legacy technology that people have in Western Europe.

But e-commerce has become extremely competitive, with razor-thin margins across the board, so it’s less exciting [to us] as investors.

What have been some of the bigger exits out of Turkey?

eBay bought the Turkish eBay clone [GittiGidiyor in 2011]; Naspers bought [the private online shopping club] Markiphoni [in 2011 for a reported $200 million]. Just this month, a British mobile payments company called Monitise, a public company, announced that it’s acquiring [the Turkish mobile commerce company] Pozitron for $100 million.

You just spent a year living in Instanbul with your family. What were your impressions of it? There’s obviously been a lot of unrest.

Turkey is seeing a crazy pace of urbanization, driven by developers with fairly limited supervision from the government, so there’s no green space in Istanbul. I worry that they’ve built this thing that’s unlivable.

The macro [picture] is also very hard. There are questions about the application of the rule of law. It’s been a rocky 12 months in terms of internal politics.

At the same time, it has good fundamentals, a pretty good infrastructure and an educated population. And people are very fast in Turkey about getting things done. Maybe people are jumpy because they’ve been rocked by economic crises over the years, so people know that you get things done now — you don’t wait until tomorrow. That’s the way things work there, though. My clock speed always goes up a few notches when I’m there.

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