This week’s episode is a compilation of the best audio clip highlights, talks, and discussions from Consensus: Invest.
If you didn’t attend Consensus: Invest, or you haven’t heard of it, it was the very first conference for institutional investors focused on cryptoassets, and it happened at the end of 2017 in New York City.
You might remember Taylor from a previous episode. He’s a popular essayist and the author of The End of Jobs.
Dhruv is the co-founder of Unchained Capital. Unchained Capital is a service that lets you take out a cash loan on your crypto assets so you can benefit from your Bitcoin wealth without having to sell your favorite investment.
In this episode, we’ve recapped Consensus Invest and compiled our favorite audio clips and discussions from the event. This episode is the next best thing to attending in person.
- Thoughts on a talk about cryptocurrency as a new asset class.
- The evolution of Bitcoin and how it has been used since its inception.
- Our take on a fascinating panel about cryptocurrency taxation.
- Some compelling existential bear cases for the cryptocurrency space.
- How institutions can gain exposure to the cryptocurrency asset class.
- What the general vibe was in the hallway of this event.
- How much the event has changed in the last year and a half.
Links Relevant To This Episode:
- The End of Jobs by Taylor Pearson
- Unchained Capital
- Consensus: Invest
- ERC20 Token
- Chris Burniske
- JP Morgan Chase
- CME Group
- ARK Invest
- Kelsey Lemaster
- Goodwin Proctor
- Jim Calvin
- Deloitte Tax
- Linda Xie
- Ari Paul
- Arianna Simpson
- Patrick O’Shaughnessy
- BlockTower Capital
- David Swensen
- Polychain Capital
- Fred Wilson
- Brad Feld
Clay Collins: This week’s news round table provides highlights, audio clips, sound bytes, and a discussion of the best of the best content from Consensus: Invest.
If you didn’t attend Consensus: Invest, or you haven’t heard of it, it was the very first conference for institutional investors focused on crypto assets, and it happened at the end of 2017 in New York City. A few years ago everyone at this event would have been wearing hoodies and jeans, but this year, stepping in the Marriott Marquis on Times Square, most folks were in suits, and some were in the Wall Street best. The atmosphere in this space is clearly changing as hedge funds, investors and family offices have poured into the space.
For today’s round table discussion I’m joined by Taylor Pearson and Dhruv Bansal. You might remember Taylor from a previous news round table, he’s the author of The End of Jobs, and he’s also an essayist and blogger at taylorpearson.me. My second guest is Dhruv Bansal, as I said earlier. He’s the co-founder of Unchained Capital. Unchained Capital is an interesting service that lets you take out a cash loan on your crypto assets so you can benefit from your Bitcoin wealth without having to sell your favorite investment. We’ll link to Dhruv’s firm in our show notes.
In this talk we discuss general themes from the conference and the tenor and feel of the event. We’ll also discuss Dhruv’s perspective of the event from the exhibitor hall, where he spent most of the conference. We’ll also provide breakdowns of four talks, or panels, from this one-day conference. The talks we’ll cover from the event are Chris Burniske’s talk Ringing the Bell on a New Asset Class.
We’ll also cover a panel on cryptocurrency taxation, which sounds boring, but is actually incredibly important for anyone who’s taken gains from their cryptocurrency investments. We’ll also review a panel on the cryptocurrency buy side opportunity from the perspective of fund managers and buy side analysts. Finally, we’ll cover a panel about financial products for institutional investors interested in gaining exposure to the cryptocurrency asset class. Please enjoy this week’s news roundup.
Let’s dig into Consensus: Invest. I can provide some context on my decision to go. I have 18 month old twins, so I don’t have a lot of opportunity to travel, the reason why I got permission from my wife to go to this event and made it all happen, because this was the first event centered around institutional investors. There have been a lot of conferences for full-time consumer investors or hedge funds that aren’t really hedge funds.
But this is the first real event that was created from the ground up to appeal to the people who run multi-family offices, people who run registered in the United States hedge funds, offices with a hundred-plus million under management. And they located the event to accomplish that as well. You had people here from JPMorgan, from CME Group. And crypto is really one of the very first assets that started out marketing itself and being available, I don’t know if you could say it really marketed itself ever, but it started out being available to consumers and it was kind of later on that it became available to institutions.
Usually it goes the other way around, that you’ve got the sophisticated financial products that are only available to accredited investors or people with a lot of funds under management and then they move down market, and everyone else kind of picks up the pieces. It was fun being part of the group that got involved early on and is now watching a very different demographic process, what’s happening from their vantage point, and so I wanted to go and see that. For me that was the significance of this event. Let’s transition to the talks. Taylor and I are going to be going over three of our favorite talks.
Taylor, why don’t you tell us about Chris Burniske’s talk and your takeaways?
Taylor Pearson: Chris’ talk was called Ringing the Bell on a New Asset Class. And as I kind of understood the talk, it was basically… Chris’ background, he was at ARK Investment Advisors, I’m not sure what the formal name is. And he had a research project to understand cryptocurrency and how they could invest in it while he was there. And I think he has his own hedge fund or some sort of private investment fund. He was trying to explain to more traditional investors, institutional investors, why he believes cryptocurrency is a new asset class. He looked at four elements. One was the investabilty, which is, is it liquid enough?
Currently, there are one billion dollars traded daily in cryptocurrency, across all the different tokens. He also looked at the political economic supply, so if you compare Bitcoin to gold, Bitcoin is interesting. It’s often talked about as digital gold, it’s a censorship resistant store value, it’s harder for the government to confiscate your gold than it is, say your money sitting in a bank account. If you have gold in a safe, it’s harder for them to confiscate. In Bitcoin, one of the key differences he pointed out is gold is not as deflationary as Bitcoin, or Bitcoin is more deflationary as gold, because you can always mine more gold.
Clay Collins: Hey, it’s Clay, and I actually want to play you a short clip from Chris’ talk where he discusses gold versus Bitcoin supply over time. Take it away, Chris Burniske.
Chris Burniske: Now, people frequently compare Bitcoin to gold. And, turns out, the supply schedule actually looks nothing like gold. Sorry to break it to the gold bugs, but gold’s supply schedule is actually slightly inflationary. Each year we pull more gold out of the ground than the year before it. If you look at the last century of supply inflation of gold, it oscillates between one to two percent a year. Again, making it slightly inflationary. While Bitcoin is disinflationary going on deflationary.
We already have 80 percent of the Bitcoin outstanding right now, and roughly three million of them have been lost forever. More scarcity than meets the eye. I just show this to show how different the supply schedule of Bitcoin is from one of the assets that it is most commonly compared to. There’s great variety in the supply schedules of many cryptoassets, but most of them, at least the good ones, are mathematically metered.
Clay Collins: Back to Taylor.
Taylor Pearson: I think from 1900 to 2000, the global supply of gold went up by something like four or five hundred percent. There was, in that sense, a fair amount of inflation in gold, they were able to mine a lot of it. Whereas Bitcoin’s supply schedule is mathematically fixed. There will be 21 million coins and everyone knows at what rate those coins are going to be produced, and it’s a very fixed amount. It’s interesting, what does it mean to be even more deflationary than gold, which is traditionally considered a deflationary asset.
That was one element of political economic supply. Another one he looked at was Bitcoin transaction value per minute. If you look at that from 2011 to 2017, in 2011 there about 821 dollars projection value per minute, and by 2017 that number was 513,000. About an increase of 500 percent. I see that there’s really three errors. Kind of 2011, 2012, you have the nerds and the miners figuring out how it works.
Maybe a thousand dollars transacted per minute. From 2013 to 2015 was sort of this era of illicit use, particularly Silk Road. Where the value increased from a thousand dollars per minute to something like 30 or 50 thousand dollars a minute. And then in 2016 and 2017 we saw a lot more legitimate uses. Licit as opposed to illicit uses of that, and the value increased into the hundreds of thousands dollars, and it’s about half a million per minute in 2017. The third component of political economic supply was the trading to transacting ratio.
Clay Collins: Yeah, that’s big.
Taylor Pearson: If you’re exchanging a Bitcoin, how much of that is trading versus actual transactions? And so, for Bitcoin, the ratio’s about two to one. Twice as much trading volume as transaction volume. Interestingly, and I would not have predicted this, global fiat currency, the trading to transacting ratio is actually ten to one. There’s ten times more trading of fiat currency than there is actually transacting because of how large FX (Foreign Exchange) markets were. And so, Chris expects that that trading to transacting ratio actually gets higher, that there will be more and more trading relative to transacting for Bitcoin.
Clay Collins: A lot of this talk was a rebuttal of the claim that Bitcoin is uninvestable because we’re currently in a bubble, and he mapped the volatility of Bitcoin versus the fame companies’ right.
Taylor Pearson: The exact comparisons he gave were the daily volatility of 2016 of Bitcoin was the same as the daily volatility of oil, and lower than the daily volatility of Twitter stock.
Clay Collins: Time out. This Clay in the editing booth. I wanted to pause this conversation because I have this clip where Chris talks about this point a little bit more. Illuminate us, Chris.
Chris Burniske: To give you an idea of what 2016 looked like, Bitcoin was just as volatile as oil, and less volatile than Twitter. And that’s not to say that oil and Twitter are shining stars of low volatility assets, but it’s more to say if you have held those assets or similar assets in your portfolio, you have tolerated a level of volatility similar to Bitcoin. I’m pretty tired of all the conversation around volatility.
Yes, it’s a volatile asset, but many assets that institutional investors and retail investors use within their portfolios are volatile. The question becomes, are you getting compensated for the risk you’re taking? And that’s where we turn to the sharp ratios, so this is a graph from the original white paper. Sharp ratio absolute returns minus the risk-free rate divided by the volatility. And we see Bitcoin on the left consistently stomping the other capital market assets.
Clay Collins: I want to wrap up this session from Chris by playing a clip of him describing why fiat currencies can be more speculative than non-fiat currencies.
Chris Burniske: Next, people say, “Oh, but Bitcoin is just a speculative instrument.” And, again, we can look at those numbers. I’ve already given Bitcoin 2017 annual trading volume at 1.4 billion and daily transacting volume at 750 million. That yields a ratio of just under two of trading to transacting. If we look at global fiat currency and we use a low conservative investment of three trillion daily in the FX markets.
250 trading days in a year. That’s 750 trillion traded in the global FX markets a year. You divide that by projections for GDP this year of 80 trillion and you get a ratio that looks more like 10. Actually, fiat currencies is much more speculated upon than Bitcoin is as a function of its underlying utility.
Clay Collins: Okay, that’s the last clip from Chris’ talk. I hope these are helpful, let’s move on.
I’m going to review the panel on crytocurrency and taxation, which really didn’t seem that exciting at first, but then, when you start thinking about all the gains that people have experienced in this space and the fact that you don’t really want to turn your back on the tax man or you could end up in a pretty precarious position. I think it is really interesting, right? If you’re a crypto project you probably need to be attending talks about regulation and knowing everything there is to know about that. But if you’re a buy side individual investor, you should probably know a thing or two about taxation.
Just a caveat on all of this, that none of this should be taken as tax advice or investment advice. Please consult a professional who is licensed to help you out. The two folks on this panel were Kelsey Lemaster, who was partner at Goodwin Procter. They’ve got about a thousand attorneys. They help investment funds, they work with ICOs, they’ve done a lot work with utility tokens. Also Jim Calvin, who’s a partner at Deloitte Tax. And it was an eye-opening panel. Clay again, and I want to cut in here to play a clip from the intro to their panel.
Jim Calvin: So this is really interesting, congress actually just this morning mentioned a proposal to create a moratorium on taxing cryptocurrencies for the next five years. So that’s great news. Just kidding! I had to wake you guys up somehow.
Kelsey Lemaster: I didn’t know about it either. That was a good one.
Jim Calvin: You were blown away, right? Um, absolutely not.
Clay Collins: That’s how it started. I wanted to include the intro joke to wake you up because we’re going to talk about taxes,which is the world’s most boring topic, after all. One of the first things that they kind of dove into was the reality that crypto to crypto transactions are taxable events. A lot of people believe that if they bought Bitcoin and they withdrew that, they put that in exchange and they exchanged it for Ether and then they exchanged Ether for 0X or OmiseGo, one of these other tokens. That these are not taxable events until they move them back into fiat. And that is absolutely not the case. Here’s a clip from the talk of Kelsey Lemaster explaining how ICO investing could be a taxable event.
Kelsey Lemaster: Most ICOs that I see, what you fund into the ICO issue is not dollars, it’s usually Ether, the RC20 token or maybe Bitcoin or something else. Now, if you’re funding into that and you’re buying a utility token, you’re funding in with probably appreciated positions in Bitcoin or Ether. Now, the IRS I think would say that that’s a taxable event for you, the investor. Because you’re taking something you bought at a low value and you’re using it to buy something at an appreciated value and that’s a taxable exchange.
Clay Collins: Got that? Cool. Back to the seemingly endless onslaught of bad news.
There was a notice that the IRS put out in 2014 about convertible virtual currencies, and it essentially said that if something is a currency or if it was equivalent value in real currency, then transactions are taxable. And it’s essentially basic property tax. That’s something that everyone needs to be grappling with. A few things, if you’re a dealer, if you’re in the money exchanger business, or if you’re a money transmitter, then gains are taxes, or ordinary income, which is actually a less favorable tax rate than short-term or long-term capital gains.
If you are miner, then the taxable event occurs when you get possession of those tokens and it’s taxed at whatever the price of those tokens were when you came into possession of them. Foreign currency rules do not apply. For example, if you went to Korea and you obtained a bunch of Korean Won, you come to the US airport, you exchange those for USD. That is not a taxable event and you cannot use that as an analogy for cryptocurrency. So, as they say in Pulp Fiction, you’re not getting out of this sh*t.
Taylor Pearson: Clay, a question on the mining. So if you are a miner, unless you win a block reward for twelve and a half bitcoin, which let’s say has a market value of 250 thousand dollars, does that mean you’re paying tax on that the moment you win the block reward of the 250 thousand dollar, or whatever the fair market value is of winning that, or you pay that’s your base price which whenever you sell it, then that’s your base you’re deducting against.
Clay Collins: My understanding from this talk is that when you receive possession of those tokens that is a taxable event. Taxed as ordinary income.
Taylor Pearson: Oh, wow.
Clay Collins: Let’s say you hold that asset, you hold it for a couple of years and then you sell it. Then you’re taxed on the appreciation of that asset.
Taylor Pearson: I know Bitcoin is not obviously a stock but it sounds very comparable to if you’ve received stock as part of some compensation package, you’re taxed on that stock as income, typically. And, indeed, if it appreciates and then you do something with it, that’s another taxable event, separately.
Clay Collins: Yeah, and that’s something that they reinforced on this panel, is that in a while, the technology that powers cryptocurrencies and distributed ledger technologies are new, the concepts here are not new at all. And so, almost everything that exists in this world has precedent around it. There’s very little that does not have precedent.
Now, there are going to be decisions made about how to interpret the laws and apply them here, but we’re not lacking in models for figuring out what we have to pay Uncle Sam in this case.
Taylor Pearson: Were there any crypto fund managers to who this information was news? Perhaps unwelcome news?
Clay Collins: Not the crypto fund managers, I think it was primarily individual investors that were a little taken aback about the news about crypto to crypto changes. What they said was that while it is true that you need to pay these taxes, it could be deemed at some point that it’s an unbearable burden on the average individual citizen, to figure out what their basis is at every single given point in time across a number of different exchanges and tokens. You have to figure out if this is being taxed as property, which it is. Now you have to do a whole bunch of work around figuring out if you sold a Bitcoin, like, which of your Bitcoin did you sell? And with regards to that they were talking about the FIFO principles, so first in, first out.
Let’s say you purchased ten Bitcoins over the course of several years, the first Bitcoin that you sell is the first one that you acquired. And it just occurred to me that a lot of the most popular exchanges that I know people are using, exchanges like Bittrex and Poloniex and Gdax and Gemini, these are all US-based institutions that require a great deal of KYC, know your customer.
They’re getting a lot about people and I have no doubt that it’s just a matter of time before the IRS starts using big data to start figuring out who to audit. I think it’s best people start treating this seriously, I really do. They had some interesting guidance on forks. You are not taxed on forks until you have what’s called dominion of control, that you have done something that shows that you actually have control of the tokens that you’ve got.
Hold on a second, I’m in the editing booth here and I’m going to hit play on the clip where Jim Calvin explains this a bit more.
Jim Calvin: The chain, so if you’ve got a hard fork with a chain split. So you’ve got cash, you’ve got gold, the way that that’s treated for tax purposes is you don’t recognize the taxable income until you exercise dominion and control. Which means you have to do something to indicate ownership of it. Which could be, you know, you split the coin somehow. If it’s on an exchange then they just do it for you and credit your account, right? But, normally, I think we would all evaluate the risks that are associated with the chain split. You say, okay well, here’s just the general risks of doing something like copying your private keys into a wallet, and you know, having it stolen. That’s one. But then replay attacks, because you want to understand and make sure that in fact there’s replay protection. So there’s good reasons not to immediately exercise dominion and control. And you could never do it.
You know, there are some air drops that you would never want to take advantage of, right? And just because there’s an airdrop doesn’t mean that you should have taxable income. The way that it works, is that until you do something that evidence is dominion and control over that property, it’s not taxable.
Clay Collins: Okay, back to the round table. This feels like inception.
So just because something like a Byteball is doing airdrops and you have the ability, theoretically, to access these airdrop tokens or, let’s say, you had your money on Zappo and then Bitcoin Gold came out and you’re not going to be taxed on the ability to potentially access tokens. You’re only taxed on tokens at the time that you take possession of them, which means maybe you move them into a wallet or you’ve done something else that demonstrates that you have control over those private keys. So for Coinbase users, as an example, they’re not going to have access over their Bitcoin cash or the ability to withdraw that Bitcoin cash until it looks like, January.
So, it’s not like August one, when the fork happened, is when taxation occurs. In fact, they shouldn’t be taxed on possession of those tokens until 2018, or perhaps never. If they never took out their Bitcoin Cash, then it’s not a taxable event. One topic that did come up as an interesting idea here is, I guess there’s something called 1031 exchange. A 1031 exchange occurs when you exchange like kind assets.
Basically a 1031 is a light kind of exchange, so if you sell real estate and then you immediately or within a reasonable amount of time reinvest that into another piece of real estate, then you don’t incur capital gains. Their saying that they don’t think this applies to Bitcoin, or if does, you’re going to have to make a case on a case by case basis, so perhaps this might work if you exchange Bitcoin Cash for Bitcoin, or Bitcoin for Bitcoin Cash. But exchanging Bitcoin for Ethereum probably isn’t going to constitute a like kind exchange. They seem to think that this is a pretty murky area. That’s what I have for the tax event.
Taylor Pearson: Cool! Well, I will talk about the crypto buy side panel. So this was a panel, the participants were Linda Xie, Ari Paul, Arianna Simpson, and then it was moderated by Patrick O’Shaughnessy. Patrick, the moderator, his background is in asset management. He runs a quantitative asset management fund. And he was talking for someone sort of from that perspective and what they should know about the buy side of crypto.
So, some of the highlights of the panel, for me, one was asking about who are the LPs of these crypto hedge funds that are popping up. It sounded as though, initially, the Lps were venture capitalists, and then it moved at this point, kind of the stage right now is a lot of high net worth individuals, particularly people who were early investors in either Bitcoin or Ethereum and want to continue investing in the space but don’t want to keep up with all the ICOs that are kind of just turning in a portion of their crypto asset portfolio to a hedge fund manager to actively invest in new projects. Who is at least hopefully reading all the white papers and doing more in-depth analysis. Ari Paul, who was one of the panelists was formerly – he has a crypto hedge fund now, called BlockTower Capital but was formerly the manager, or one of the managers, of the University of Chicago’s endowment fund, and I think has an interesting perspective because he does speak both the language of cryptocurrency and distributed systems, and the technical side, but is obviously very fluent in finance and how those people think.
One of the his points, he referenced an interview with David Swinson, who’s the manager of the Yale endowment, I think its kind of why he’s respected as one of the smartest, most well-instructed money managers. He was asked when will the University of Chicago invest in Bitcoin. And he said six months after Swinson does.
Clay Collins: Yo, Taylor, I’m going to let you finish, but I’m going to play this clip of these folks diving into this whole Yale thing a little bit more.
Panelist: One the things we see a lot is career risk governing a lot of what happens in any investment asset class. I was asked at a dinner I was at when the University of Chicago might invest in this. And his answer was something like six months after Yale does. And there’s this incredible kind of momentum that can be created. And maybe we’re beginning to see that.
Taylor Pearson: If Yale buys Bitcoin, then every other endowment in the country will buy Bitcoin, because they can all kind of say, well, David Swinson bought it, so we buy it too. If it does, it’s kind of into the psychology of how some of these larger, guess you could call it more conservative or more traditional institutional investors are thinking that there’s a lot of reputational risk involved in these assets, not just the technical, or you know, how does it correlate with other assets.
How are my LPs, or how is my career path going to be affected by decisions I make regarding crypto currency right now. Is it that much more beneficial for me to do this now versus waiting a couple of years and maybe add some bigger names or some people with cache in the industry. Step up and talk about. One of the other interesting points, There’s a liquidity problem in terms of how deep the market is. There’s lots of liquidity, or sufficient liquidity, at least in terms of Bitcoin and Ethereum for some larger institutional investors but once you get down past maybe the top fifty or the top one hundred by market cap tokens, there’s just not enough liquidity for an institutional investor to be able to invest, just the market capitalization and the liquidity is too small.
Clay Collins: That’s actually really important to kind of acknowledge. We’re all really impressed that the, you know, collective market cap of all crypto assets right now just passed half a trillion. BlackRock has $5.7 trillion under management. Like, one hedge fund could come in and essentially buy up the entire cryptosphere, and wipe it out. Though we haven’t even begun to see the difference that this kind of wall of institutional money coming into the place will play.
Taylor Pearson: It’ll be interesting. One of the things they were concerned about, one of the topics was one of the bear cases, one of the most compelling, existential bear cases for the cryptocurrency space. The three that came up were regulation, that the SEC steps in a very heavily-handed way, potentially even banning it. Alternatively there are some arguments that might increase adoption.
If everyone sees Bitcoin as a censorship-resistant asset, and the government bans it, it could be kind of a book-burning phenomenon, where as soon as the Catholic church outlaws the book the sales spike, because now all of the sudden everyone sees the value. So that could potentially go either way. It would certainly make it more difficult.
Clay Collins: Or guns in the United States.
Taylor Pearson: Or guns in the United States, exactly. But certainly regulation would make it, depending on the regulation, would have a big impact on institutional investors. Other compelling bear cases, some sort of technical issue, there’s a vulnerability discovered in the actual protocol, in the code base, as in a technical issue. Or potentially miners colluding, if it came out that sixty percent of the has power in the Bitcoin network was colluding, and they were someway manipulating the network. That would question the integrity of the network and cause a huge potential decrease.
And then the final bear case was, just basically spammy the ICOs, drawing in regulators in a very negative light. ICOs walking away with money, not building the technology that they promised, which would both bring in regulation and potentially cause new investors, maybe it was one of their first experiences in the space to say, “I don’t want to be involved with this.” At least not in the near future where this is the standard business practices.
Clay Collins: Well if that’s the best they can come up with in terms of bear cases, I’m feeling pretty good about Wall Street’s potential ability to get in here. I don’t find any of those things to be too large of a threat, especially when you consider that this is a global asset, right. The regulations that would just apply in whatever jurisdiction they’re being regulated, the technical issues, this is a technology that can fork, that can upgrade consistence mechanisms. They can upgrade all kinds of components of the technology while still maintaining the historic ledger. ICOs, yeah, that’s just kind of like reputational risks for the space. I don’t see any of these three as being a big deal.
Taylor Pearson: I think there was a great post to Reddit. Someone had complied a pretty complete list of possible attack vectors on Bitcoin, and they range from everything from nation states to private corporations, to technical flaws, to government, to self-governance issues. It was a really compelling list because firstly, many of the attack vectors had already happened. It’s quite clear, spam attacks with low fees on the mempool, various private corporations putting out newsletters or information about how Bitcoin is quote unquote worth less or doesn’t work or comparing it, say only criminals use it and these kinds of things.
A lot of those we’re familiar with, but there were some really compelling attack vectors like literally what if someone today knew about a flaw in the Bitcoin source code, a zero day so to speak, and just wasn’t using it. I find some of those to be a little bit dubious because there’s a lot of money to be stolen if you can figure out how. Bitcoin is compelling just because of how long it’s been around. It’s been able to create that thermodynamic fire wall of hash power that people will never get past. That’s very compelling. It’s one of the things I find most compelling about it.
Clay Collins: It’s literally the world’s biggest bug bounty.
Taylor Pearson: It is literally that. Yeah, that is a great way to think about it. And it’s held up to 10 years almost of almost every good hacker in the world who hears about it wants to give a go, and no one’s been able to so far. That’s pretty tremendous. But at the same time, I don’t think Bitcoin’s self-governance processes have been as excellent and as well forethought out as some of the chains that have followed.
I think people have seen how difficult it is to govern a system that has no leaders, and they’re trying to build in primitives that make self-governance a little bit more effective. I could see that as a pretty existential threat to Bitcoin one day, of some kind of chain that tries to do everything Bitcoin does but at the same time just does it better because of more fluid self-governance. But at the same time, we do run into that original issue, that Bitcoin is the world’s largest and most long-running bug bounty of this scale. And so even if some coin were to come around with a fancy dancy property over here or a better way to do X, Y, and Z new thing, it’s very difficult to overcome that initial advantage.
Clay Collins: One of the things that I heard over and over and over again, primarily during this and a variety of other talks, is this idea that a lot of people or a lot of institutional investors expected this thing to be dead by now. And every time it looks like it’s going to die and it just doesn’t die, it develops more confidence or people develop more confidence in the asset class. And I almost got the sense that the institutional investors there, most of them expected this thing to be gone by now, and at some point they just couldn’t ignore it because it has just been so resilient. It’s almost like they just woke up one day and were like ah this isn’t dead yet. I might just buy some because my suspicions haven’t been confirmed at this point.
Taylor Pearson: Ari Paul also mentioned often Bitcoin is talked about as digital gold, and people compare it to the market of gold, which I think is around six or seven trillion. Offshore banking, I think, is about a 20 trillion dollar, there’s 20 trillion dollars in offshore banking, and there’s a lot of overlaps there in terms of censorship resistance and judge resistance. Companies like Amazon and Google have assets in many different jurisdictions, so if a judge in one jurisdiction freezes their accounts, they can’t terminate the whole business.
They can sure diversify that risk across different jurisdictions and some sort of public blockchain. Potentially Bitcoin offers very similar or potentially even better benefits to something like some of the use cases for offshore banking.
Clay Collins: Hey, this is Clay again in the proverbial editor’s booth, because I think this is one of the most interesting points made at the entire conference. Let’s roll the tape of Ari Paul explaining why institutions need judgment resistance. Pay attention. This is good.
Ari Paul: There’s two terms that are similar but slightly different. Censorship resistant means no one can prevent you from sending that information. So if I want to send money to a politician, to Wikileaks, I can’t be stopped from sending that. And that’s actually a real issue with US dollars, because for example, a bank won’t allow you to wire money to many locations. And it can be hard to physically send cash and can even be illegal. So with Bitcoin there’s now a Bitcoin satellite which is pretty incredible.
So even if you don’t have an internet connection, if you have a $150 satellite dish, you can send Bitcoin to anyone in the world. And the other is judgment resistance. Judgment resistance means it’s very hard for a judge or government to take it from you. And that may sound like it’s attractive to criminals, but the offshore banking system is about 20 trillion dollars. Every large US company makes use of it. So Apple, Amazon, they all use offshore banking, and all the big banks like JPMorgan facilitate that and collect fees.
They’re not doing it because they’re criminals. They’re doing it because if you’re Amazon, you can’t have your entire business shut down by a single judge in one legal jurisdiction pre-trial. So imagine if all of Amazon’s money was in New York state and a New York state judge said we suspect you of something. We’re just freezing all of your accounts, and then the next day Amazon can’t make payroll. Instead Amazon has their assets stored in every legal jurisdiction around the world, and if they end up losing that case, maybe in five, maybe in 10 years they’ll actually get shut down, but they have their chance in court. Bitcoin is censorship and judgment resistant, is providing a very similar service to the offshore banking system, but providing it much, much better.
Clay Collins: Back to you, Taylor.
Taylor Pearson: The other couple things I thought were notable, one question is, with these ICOs, is everyone investing at 50 million dollar market caps, which would normally be a three to five million dollar seed round and just as a category, the entire ICO space is ridiculously overpriced and no one investing in it now will make any money in the long run. And then one of Ari Paul’s points was from a risk perspective, an endowment putting 1% of their funds into cryptocurrency reduces risk overall because it is uncorrelated with the rest of the portfolio so that the risk is so small that it effectively gets diversified away. And then you’d have some potential for a meaningful amount of alpha that if you invest 1% and that goes up 500% or goes up 10 X again or something over a period of a year or two. That’s a meaningful alpha for a fund to be able to add to what they’re already doing.
Clay Collins: Time out, time out. Let’s play the clip of Ari making just this point.
Ari Paul: Something that actually frustrates me a lot, so I’m very very open about the risks of the space, the operational risk, the security risk, the hyper-volatility, the regulatory risk. But kind of a really, really core concept in finance and in portfolio management that everyone at endowment had to learn five times over is the idea that you don’t care about the risk of an asset or a stock. If I invest in the S&P 500, I don’t care that one of those stocks is a coin flip and it’s either going to be a hundred percent up or a zero if it’s, say, a biotech that is waiting on FDA approval. You don’t care about that because it’s 0.5% of your portfolio. That risk is called idiosyncratic risk, and it gets diversified away. What I get frustrated about is when I talk to these people who know this, they’ve taken those MBA classes, they’ve gotten their CFA, and they say something like yeah, it’s too risky. It’s so volatile.
And my answer is always well, it actually decreases the risk of the portfolio. If you put 1% of an endowment in cryptocurrency, it actually reduces the risk because it’s uncorrelated to the rest of the portfolio. And so the risk, that volatility, gets diversified away. And the risks other than volatility, things like operational risk, those are the things you want to get paid for, because normally as an endowment you’re getting paid to take beta risk and duration and illiquidity. The opportunity to get paid, to take an uncorrelated risk, is fantastic because it’s a tiny, tiny percentage of your portfolio gets diversified away. So I try to explain that to them and say this is not about, don’t look at this in isolation. Don’t look at cryptocurrency as is this risky or not. Look at it as 1% addition to your portfolio, and say is my entire portfolio meaningfully more risky or not. And the answer is it’s not.
Clay Collins: So I’ll transition here to the talk on new tools and products. This was essentially a panel about how institutions can go about gaining exposure to the cryptocurrency asset class. This is a really great group of people. They sort of did this panel by describing this phenomenon of Bitcoin not dying and at some point being unable to ignore something when it is so resilient. They talked about how custody is the single biggest issue for institutions. Remember, if you’re a fund with over 150 million under management, you need to find a custodian that will hold these assets for you.
I think that’s fine and somewhat easy to do at this point if you want to hold Bitcoin or Ethereum or forks of Bitcoin or ERC20 tokens that run on top of the Ethereum blockchain, but if you want to hold things like Tezos or other blockchains that aren’t forks of Bitcoin, this becomes really hard to do. If you want to get into the Bitcoins, it’s pretty easy. If you want to go elsewhere, it’s pretty hard to do. Another problem that they identified was just lack of institutional infrastructure. It’s hard to get things that hedge funds are used to having access to, like prime brokerage, ETFs, margin trading is hard to do. It’s hard to short this stuff if you want to. It’s hard to get people to loan you tokens in a way that makes sense.
They talked about how primarily the institutional investors that are participating in this asset class are family funds that have a lot of discretion for how they allocate crypto hedge funds that are explicitly designed to get folks exposure to this asset class. Again they can be nimble because that’s what they’re designed to do. And some hedge funds, like global macro funds for example, that have a lot of discretion and are looking to get some exposure. Time out again. Let’s roll the tape on a clip from the panel where they dive deeper on this topic.
Panelist: I would add on to that that I think that the narrative around this has changed dramatically, maybe even over the last 12 to 18 months. I think 18 months ago a typical hedge fund, global macro fund, whatever may be, would never even dream of writing about Bitcoin or digital currencies in their quarterly LP letter. And now their LPs are calling them up and saying why don’t you have exposure to this asset class.
And so whereas it maybe used to be the managing directors of these firms that were personally dabbling in this space, now they kind of feel like they have no choice but to start looking at this space, getting smarter on it, and starting to make small allocations. And so what we’re kind of experiencing is seeing allocations anywhere from as little as 50 basis points to three, four hundred basis points. And in those types of scenarios, they’re almost looking at an investment in digital currency as a call option. If this goes to zero, which a lot of people are having a hard time identifying why that might be the case, it’s not going to be a material drag on any of these single fund’s performances.
But if it continues to have the kind of outsize returns that it has been experiencing and we all think we’re still pretty early in the life cycle where these assets can develop to, well then it becomes this really meaningful driver of performance. And so I think approaching digital currencies, including digital currencies as part of a diversified portfolio is something that a lot of portfolio managers are really starting to catch onto and also starting to look at validation, having CME Group launching futures and having the rhetoric around digital gold or digital store of value starting to really resonate with them as well.
Clay Collins: Back to the round table discussion.
What I found interesting from this panel was the fact that Circle was even there in the first place. I always thought of Circle as a consumer mobile app that is kind of a competitor to Paypal or Venmo or Square Cash, but it turns out that at some point, the OTC trades they were doing kind of, not off the record from a regulatory perspective, but people didn’t really know that they were doing OTC deals for liquidity purposes. That started to dwarf the consumer business, so they’ve gotten into that in a much larger way. It used to be that it was a big deal when they did a million dollar trade, and now the average size of their order is about a million dollars, but they routinely do 10 to 40 million dollar trades. They also are willing to participate, Circle is, the Circle OTC desk, which you can find at circletrade.com, they’re working with Bitcoin Cash, ERC20 tokens. It sounds like they’re being pretty aggressive about the ability to work with different tokens.
They are not a broker dealer, so they’re not allowed to sell anything that sort of smells or looks like a security, which is kind of a common theme. GDAX does the same thing. Grayscale was up there, which runs the Bitcoin investment trust, the Zcash investment trust, and the Ethereum Classic investment trust. They kind of had some product announcements. They talked about the fact that more of these investment trusts are coming. I find it odd that the three they picked were Zcash, Ethereum Classic, and Bitcoin. Of course Bitcoin makes sense, but Zcash and Ethereum?
I think those are fine projects. I just don’t understand why those were the number two and three. They talked about how they’re coming out with a basket product that’s going to hold the top five crypto assets by market cap and then rebalance across them quarterly, and they’ve seen a lot of demand from institutional investors that are used to being able to just call up their broker, place a phone call and buy something that they’re looking for exposure to.
They also find that it makes sense when people have tax advantage money that they want to put to work, like money from an IRA, that it makes sense to not hold the asset yourself so you can kind of keep it within your IRA or whatever tax advantage bubble that that money is currently in. I’m starting to understand a little bit why people are doing this. In 2013 the Bitcoin investment trust was only available to accredited investors, and then at some point, I don’t recall when, it started being publicly listed. So you can go into your Schwab account or whatever and purchase it.
So it seems like it is at kind of a nice point en route to having a Bitcoin ETF. So that was kind of the news from Grayscale. GDAX talked a little bit about what they were doing. They described that their trade volumes are up 10 X this year. 10 X, holy crap. And the reason why Coinbase created GDAX was to provide a place for institutional investors to trade, but more than that, it was to get liquidity for Coinbase so they wouldn’t have to call up Circle. They can kind of source the digital assets themselves.
They also talked about Coinbase’s custody product for institutional investors. So Coinbase has a vault which is available to their retail users. They needed something that funds could list in their filings as their institution. And they are looking to be, in some ways, a prime broker and a custodian for these institutions, and I think that’s largely why they were there and that’s what they were interested in talking about.
Taylor Pearson: I will say the one thing, I saw this panel as well. The most interesting thing to me was the custodial aspect just kept coming up over and over. My meta themes from the event were why isn’t institutional money involved, and it basically came down to reputational risk and custodial risk. And so a lot of the products they were talking about here, as I understood it, cause they’re trying to kind of solve, at least GDAX custodial product, they’re trying to deal with this custodial risk.
Clay Collins: Tell us a little bit about the hallway track. What were people talking about in the hallways? What was the back channel signals that you were picking up on?
Dhruv Bansal: So I’m definitely a hallway guy at conferences. I’ll admit to that. I have enjoyed certainly sessions in my life, but I tend to find that often they are at a lower level of detail than I desire or they’re unfortunately rushed or they get distracted. I prefer to roam the halls, and I tend to want to meet as many people as I can and just kind of learn what they’re working on face to face.
So that’s exactly what I did at Consensus Invest last month, but it’s also something I did at the Consensus conference back in May of 2016 which was the previous conference that I had attended that Consensus put on. I did not attend the one in May of 2017. So that was about 18 months in between those two conferences. They were both held in the exact same city in the exact same hotel. And so it was a really interesting experience for me having attended the one in 2016 and then attending, of course, Consensus: Invest this past month.
It was a major shift in the kinds of conversations that I was having, they type of people who were there, what they were interested in, what were the compelling problems they wanted to work on. I think that’s a good way to introduce kind of what I want to talk about as major differences, like what’s new now that people cared about today versus what were they talking about a year and a half ago. So it’s important to remember a year and a half ago the Bitcoin price was $400. Market cap was like, seven billion dollars. Ethereum was $10 a coin. Market cap was just reaching a billion dollars which was exciting at the time. Prices in everything in crypto, I think those of us who’ve been holding for a while or who are in the ecosystem recognize that we don’t control the price and so it doesn’t mean everything, but it does mean a lot.
Folks in Consensus 2016 had a very different makeup and attitude towards cryptocurrencies than they did at Consensus: Invest this year. In 2016, most of the conversations I was having with folks were ultimately about technology. They were, what is Bitcoin, and then how can I use it? Which exchange should I use? What is a hardware wallet? Should I get into it?
Are there companies that can help me build a private blockchain? There were a lot of banks, and there were a good number of institutions at the Consensus event back in 2016. It wasn’t just individuals. There’s absolutely a lot of institutions there. But their chief goal was, in my opinion, not to understand Bitcoin, Ethereum, or the other public blockchains. They were there to use blockchain technology for themselves, so however and whatever that meant. I think the mantra Bitcoin bad, blockchain good, very common to hear that during that era. It makes sense, i suppose, because the price was, it hadn’t been doing very much. It was much lower than it is. Perhaps it was a reasonable opinion to hold that the promise that Bitcoin may have held, it wasn’t going to realize. It had collapsed from a thousand dollars down to this lower price and just stayed there for a while.
So I think maybe it was reasonable that the opportunity people saw was building their own blockchains and doing something new themselves. By this year, of course, that was totally different, totally the opposite. Bitcoin’s price was just reaching 10 thousand dollars the day of the conference, which was fortuitous timing for everyone. The market cap is 160 billion dollars. Ethereum was up to 480 with a market cap of 45, 46 billion. The ICO craze had already happened in 2017, so everyone was aware of that. Some were even talking about how it was winding down, which I guess is perhaps fair to say compared to some of the heights of May and the summer this past year.
But what I thought was interesting was in comparison to the prior event that I had attended, 18 months prior. Bitcoin, Ethereum, Monero, Zcash, Dash, these were the things that people were talking about. The public blockchains were where the party was. It’s what everyone wanted to be better connected to. They wanted to understand how to invest in those things better, and it went much past just where to buy some. There were very few exchanges trying to educate you about hey, we’re a place you can buy some. That was sort of understood.
The major themes, I’ll talk a little bit briefly first about just smarter and better and richer ways of investing, which I think was a big part of what I saw there, and then we can get a little bit more into some of the non-investment oriented projects which I thought were interesting. Let’s start with protecting investments. This was, I think, the biggest difference between what I saw this last month and the year before was that when your first question is well how do I get some, you’re not ready yet to hear about how do you protect it.
If you’ve had some for a while and you’ve watched some hacks go down and the price has suddenly gone up by a factor of 10 X, you are way more oriented around well how do I protect what I’ve already got. Hardware wallets were a lot more normalized this year. I saw a lot of people carrying treasures and wallets, which, by the way, don’t bring your hardware wallet to a Bitcoin conference. It’s a terrible, terrible idea. Don’t do that. But I did see many people with their wallets doing cool stuff, showing how their wallet, how it integrates with some software they wrote or whatever. I hope they were testing out wallets, let’s just say that. But I would say the biggest thing I saw were custodians and trust companies. That is such a distinction from what I saw previously, and it supports the point that you guys have been making, that this was really a bigger event for institutions, and this concept of custody is really, really important. It’s a deep need to be able to store this stuff safely. There were several vendors there.
I won’t name any just to not show any favoritism, but at least five or six that I spoke to in depth, they all had a similar attitude towards custodianship, using cold wallets, which I’m happy to hear about. Of course no one was willing to talk about the details of how they do everything, which I think is also smart. But the major distinguishing point seemed to be well which assets do you work with? Do you only do Bitcoin? Do you do Bitcoin and Ether? Do you do ERC20 tokens?
One firm actually just changes the context of the problem and says they just protect private keys. They don’t even think about them as crypto anything. So if you can just give them a private key, they’ll protect that for you. So that’s interesting as a sort of low level way to go cross tokens. So I thought that was a major shift in the focus, was trying to do this stuff very safely.
That was kind of curious to me because the other big change that I saw was that the conference was full of folks who were affiliated somehow with crypto funds, investment groups, so called sometimes crypto hedge funds, though I think that name is actually inappropriate. It’s obviously been a massive trend of 2017 with the rise of many, many, many different tokens through the ICO and ERC20 process. And so what I noticed is that crypto fund managers were some of the most popular people at this event, that if you were a well-known crypto fund manager who’d been writing well, speaking your mind about the various tokens, becoming a thought leader, everyone wanted to talk to you.
They wanted to get your opinion about what you thought about their coin, what you thought about this other guy’s coin over here, what things you were buying, what you weren’t. I would say the other thing that I thought was really interesting, and Clay, you guys definitely played into this as well with Nomics, but investing smarter is not just about protecting your funds, not just about working with professional asset managers. It’s also about using the right data. I’m a very data-driven person.
My history working with a data company means that when I approached Bitcoin I started by looking at the data, and that’s what helped me realize how much of Bitcoin actually doesn’t get spent, how much of it sits around, et cetera. I’m a very data-driven person the way that I think about this field. It was great to see other people really taking up that mantle, your own firm and a few others working really hard to put out good, original, trustworthy, fast performing sources of data for traders, for investors, for fund managers.
But it’s really nice to see companies now working on aggregation and syndication of that information in ways that are machine-readable and in ways that are consumable at a large scale by existing data marts. That’s really valuable stuff. And I think even beyond just the data, I was really, I’m a nerd, and I’m never going to be happy with data. I’m always going to want more. But I thought it was really cool to see folks branching out from just repeating or just re-aggregating information and starting, just a little bit, to get into some secondary or derived metrics.
So instead of just quoting prices and volumes or asking bid spreads, which I’m not going to trivialize, that’s very difficult given the fragmented state of the market today, but going beyond that and saying well here, what if I offer you a data set you can buy which shows you the cross correlation between various trading pairs or how various exchanges co-move or anti-move with each other. I think that’s super interesting stuff.
Clay Collins: It’s funny you mention that and kind of the personal brands that were popular there. I think everyone is looking for guidance, whether it’s a person or a data. I definitely felt like the rock stars there in terms of personal brands were like, Ari Paul, Chris Burniske, the people from Polychain Capital. These public crypto hedge fund manager, writer, blogger, folks seem to have quite a crowd around them.
I think there’s a real hunger for that. It in a lot of ways reminds me of what happens in venture capital, where folks like Fred Wilson or Brad Feld, some of these VCs that get a lot of their LP flow and their deal flow purely through writing on their blog. There really is just a thirst for both data and then synthesis on that data. People, they know they’re at a cool party, but they want the lay of the land. They want to know where the cool kids are. They want to know now that they’re in this new space, what are the rituals? What are the customs? Where’s the bathroom? Stuff like that, if we can use a party analogy.
I felt that pretty strongly. Well this has been a fantastic round up. You both have been very generous with your time and your insights. Thank you for coming. Thank you for participating in this. If folks want to get a hold of you, what would be the best way to go about doing that?
Taylor Pearson: So I’m @taylorpearsonme on Twitter. Twitter is probably the best place to get in touch with me.
Dhruv Bansal: Yeah I’m also on Twitter. You can find me @dhruvbansal. It’s a harder name to spell than Taylor Pearson, so maybe look it up from the notes in today’s show. But if you’re interested in learning more about lending or borrowing using unchained capital, check us out online, unchained-capital.com.
Clay Collins: Fantastic, thank you so much.
Dhruv Bansal: Thank you, Clay. Thanks Taylor.
Taylor Pearson: Thanks.