Animal Spirits Podcast - Looking Back at the Crypto Meltdown

Episode Date: July 30, 2022

On today's show, we get an update on crypto from Meow CEO Brandon Arvanaghi and take a look at what happened with the recent crypto meltdowns.   Find complete shownotes on our blogs...  Ben Carlson’s A Wealth of Common Sense  Michael Batnick’s The Irrelevant Investor  Like us on Facebook  And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.  Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain position, and the securities discussed in this podcast.

We are joined today, rejoined by Brandon Arvinaaghi. Brandon is the co-founder and CEO of Meow. Brandon, thank you. Thank you, Michael. Thank you, Ben. All right, a reintroduction for the audience. Who is Meow? Mia is a compliant bridge to crypto market yields for corporate treasuries and high net worth

individuals. So you deposit dollars, you can pick the yield source from the crypto markets and earn potential yields from it. So let's start out with some congratulatory news. It's been a pretty dark space for crypto, but there is a little bit of a bright light. You and your founders were able to secure a large funding in this difficult environment. I have heard of term sheets being pulled all over the place. What was it about you and your team that allowed you to not only, I mean, this is a big deal, which we were

thrilled to be part of, by the way, full disclosure. So talk about that. Yeah, so we started raising end of April. The Ukrainian roar had already started. So the VC market was already bad, but it got worse and worse every day. I mean, the Fed rate hike started shortly after and everything was tanking. We luckily got term sheets, a week and a half into it, competing term sheets. And what we saw very clearly is that this is not 2021 anymore. So 2021, you could crap in a box, call it Web 3, and you get a term sheet. But this was all about fundamentals and revenue. Everything flipped on its head. So that's the only thing that saved us. And we're with Tiger now, which we're very pleased about. So when you say that's the only thing that saved you,

what saved you, the fundamentals of the business? Fundamentals, yeah. There was no narrative pitching. I couldn't talk about like the vision or anything like that. That's all I did in 2021. But they were more interested. Everyone was interested in the metrics. now. Okay. So not only were you pitching while there was like macro uncertainty, but was this right in the middle of the Tara Luna blowup? Yeah, so we signed the term sheet. There's a 30-day diligence process typically. About two weeks into it, first of all, the Fed raises rates, everything tanks. U.S.T. blows up. That was a big deal. Three AC went under shortly after, but the U.S.T blow up, everyone was texting us saying, hey, is meow okay? Yeah, because we pass that IQ

test. We never listed them as a yield source. That's what unfortunately a lot of retail yield apps did, I could talk about for hours, honestly. Brandon, how is the general state of confidence for institutions right now in the crypto space? Because obviously they have to be a little shook. And sometimes this happens where different lenders just get lumped in because there were some bad actors in the space. So how are people feeling now if you had to gauge the sentiment of people on this space in crypto? Well, I think they're rightfully skeptical about a lot of the options.

I mean, everyone pretty much took losses from 3AC because people were lending to them either unsecured or with partial collateral. and pretty much every lending desk it looks like took losses. So their equity cushions had to kick in or they needed a bail out in most cases. So that's the reality of the markets and it's very understandable for people to be skittish right now. All right. So let's pause and talk about this story and how it unraveled. And when did you first start getting indications that there was trouble brewing? So the first thing that happened in the crypto markets was Celsius pausing withdrawals, if you remember that. That was before Taraluna? Yeah, exactly. Well, I'm not sure

about the actual timing of that? I don't think so. It was after, you're right. It was after, but it was before 3AC news. Right, right. When Celsius paused withdrawals, we thought that was kind of a dud. It was not much news because the institutional lending desks that we were partnering with, the market makers, et cetera. No one's lending to Celsius in the first place. Celsius is doing cowboy things, frankly, in the space for quite some time. They weren't lending to them directly. So that's fine. That was one thing. There was a day shortly afterwards where do you remember Bitcoin's price was just crashing candle after candle? Yes. There was no bid, it seemed like.

We couldn't make heads or tails of that at the time because the only news that was out there was a Celsius news. What started happening was rumors about 3A, which was unheard of in 2021. Everyone thought they had like a fix on the market. Everyone thought they were delta neutral or super smart, sci-opping people. That would have been news. If that is true, we thought to ourselves that that is major news. And we knew that a lot of these lending desks would be taking losses from them. There's a lot to unpack here.

Why don't we just start with Celsius for a second? Because they were certainly a bad actor in all of this. They were marketing 20% yields. They were marketing that banks are dumb and whatever, whatever. What exactly were they doing in order to generate whatever yields they were legitimately or illegitimately generating? So some of the rumors that have gone out there, and I can't speak definitive because I was on working there obviously, but since even 2021, they were caught in like the Badger Dow Defy

exploit, for example. There were rumors about them getting unbanked by prime trust. There were rumors about them getting Bitcoin collateral. then re-hypothicating it for some speculative purpose. And what seems to be coming to light now is that they may have actually been using new customer deposits to pay off other ones. I mean, there's a word for that, if that's really the case. The other thing that was very speculative, which I believe they did, was take ETH deposits. So deposits in ETH, putting it into a different asset called STEath and having a liability in ETH, assuming that these are the same

asset, basically behind the scenes. And they're not. There's no rule that says they'd be the same. So what was the motivation behind that? Because a lot of people keep saying that they were putting it, is ST. ETH? Does that stand for Staked ETH? Or did I make that up? Yeah, exactly. So they put that there because when the merge happens, then what? But it seems like there was an asset liability mismatch. But why were they putting it to ST Eath in the first place? What was the upside for that? Because the idea is SD ETH will accrue interest over time in ETH. And when the merge happens afterwards, you'll be able to redeem all that real ETH and all of the interest. But there's no timeline for the merge. I mean, it could be in five years. We think it's going to be this

year, but it could be forever. So calling that even like a duration issue is very generous. It's fundamentally different asset. And so the merge is what exactly for people that don't know? It's Ethereum's transition to proof of stake effectively. We've been talking about this for years and years, and it seems to actually be coming to the conclusion now. They're targeting this year to have that happen. Brandon, there's been a lot of attention paid to the lenders, but you talked about Bitcoin just crashing seemingly every day there for a while. What were the borrowers doing at that point? Did the borrowers completely pull back to or at that point, do people have to borrow more Bitcoin to short? Like, what in terms of like the institutions and the hedge funds, what are they

doing at that point? Those candles going down and down, what it turned out it was, very likely, was 3AC actually getting liquidated. That makes sense in hindsight because there was no bid and it was just candle after candle billions and billions taking place there. There was a lot more demand from tradfis to short Bitcoin. And there has been for quite some time. The past like month and a half, two months, the rates on Bitcoin have gone up dramatically because you need to borrow Bitcoin to short it. What does that look like if you had to, like, throw a ballpark average? What does it cost for someone to short Bitcoin if a hedge one wanted to do that? I think rates right now for Bitcoin might be like 3.5%, something like that.

Traditionally you're looking at like 0.5%, 1%. So substantially increasing. So that's why lending over collateralized, there are fewer lending to us that wants to provide Bitcoin collateral to you because there's a huge cost of capital. They could be earning 3.5%, 4% on that Bitcoin by lending it to someone who wants to short, for example. All right. So you just talked about one of the areas of demand for Bitcoin is from short sellers. Let's talk about the legitimate part of it, which you guys are engaged in. Where else is the yield come from now? What Meow is doing and we'll get into that. You guys are not offering 20% or even close to it. Where are the legitimate sources of yield coming from?

Well, it's from kind of the institutions that would have looked like 3AC, but we're not fraudulent and would be posting collateral, actually. So a lot of crypto hedge funds will post Bitcoin collateral. traditionally in normal markets and borrow dollars against it. Right now you're not seeing that because the Bitcoin borrow rates are so high. The problem with the 3AC news was a few things. Number one, people didn't get collateral from them. Number two, it sounds like they might have been re-pleging the same collateral to multiple places. And number three, it sounds like they might have been lying about their balance sheet. So if I'm a lending desk, for example, it might make sense on paper to lend them a billion dollars unsecured. If they're telling me that they have a 15 billion balance sheet, I mean, what's the worst that can happen? But if there was actually

fraudulent behavior there, which sounds like it might have been the case. That's why everyone got caught taking losses. That's why their equity cushions had to kind of kick in. Can you talk a little bit about how the collateralization works for you guys? Because I know the last thing you talked about how you over-collarize your loans. What does that look like? And how does that differ from some other lenders? Yeah. So what happens when you go to meow is that we don't run our own book. It's not like an interest-bearing account and you don't know what we're doing behind the scenes. You actually have to self-select your yield source. So be it an institutional lending desk by name. And over- collateralized lending desk where we actually hold the Bitcoin collateral against that lending

desk by name or a defy protocol by name. So investors have to self-select. They know exactly where their dollars are going, number one. Number two, we only face accredited investors. So one of the big problems is that retail users were the ones that are holding the bag right now from the 3AC from the UST issues because you had retail yield apps facing the most uneducated people in the entire market, promising them 20% yields when all they care about is the highest number in retail. And that's why they got screwed the most here. So yeah, we only face accredited investors too. You mentioned that the ability to choose your lending source there, who are these lending sources? And how many are there? And what do those options look like? Yeah, so institutional

lending desk is one general category. We have versions where you could go unsecured or over collateral is where Meow actually kind of serves as an insurance wrapper. We hold the Bitcoin collateral against them. So it's an added layer of protection. There's market makers going kind of directly to the source. And then there's defy protocols. We would offer Maple Finance, for example, which is an example of unsecured lending that would take place on chain. Now, as you can imagine, everyone's more interested in over collateralized right now, and we're not even offering the unsecured options anymore. We actually called customers ahead of time to say, hey, we have your funds in cash if they had chosen an unsecured offering during this downturn. So obviously, if people take a little

more risk and don't have as much collateral, they're getting higher yields, that's the tradeoff. You have more collateralization, lower yields, less collateralization, higher yields. So you're finding that most people, because they're maybe a little more defensive or concerned right now, are saying we're not going to shoot for higher yields, we're going to accept the lower ones. Oh, 100%, yeah. I mean, the unsecured borrowing rates are so high. They're in the tens of percents right now, but nobody wants to do it right now. So what are the yields on over-collateralize stuff? Because you're competing with U.S. Treasuries at this point. Maybe not at this point, at a certain point. So what's the spread like? It depends. Some lending us aren't offering right

now because the cost of capital, because they could be lending that Bitcoin to a TradFi that wants to keep shorting, for example. But if you find, for example, a Bitcoin minor who's not lending the Bitcoin to get yield on it, they want cash to scale up their operations. They're sitting on a ton of Bitcoin, they might be willing to pay like four percent, four and a half percent. As opposed, like, when it comes to the risk-free rates of what the Fed's offering, there always has to be a premium assigned to borrowers in this space. Otherwise, no one's going to choose that over the risk-free rate. I always see that delta coming in and these yields in crypto being at a premium to the risk-free rate.

So what sort of spreads are we talking about? Because, honestly, 200 basis points sounds insane. That does not sound like enough to compensate me from my troubles. If an overcollateral is offering, for example, where there's 150% Bitcoin collateral, a margin call at 125%, and the ability to auto-liquidate if that value ever drops below 105%. And that's paying 5%. It's all up to people's risk profiles. I think treasuries are a healthy part of any balance sheet. I think there's also a space for the potential higher years of a crypto market source as well. Okay. So just to go over that again. All right, 150%. So you're lending a hundred bucks. You're getting $150 worth of Bitcoin. There is a margin call at you said $100. 25%. Yeah, just that's hypothetical. And then if they don't post, you liquidate at 105%. So there's obviously a danger. I don't know where the risk is that I'm missing. Maybe you could talk about that, but it sounds like this is a relatively, I even like shut it to use the word safe, given what just

happened. But there's layers of protection here. Yeah, there are. I mean, there's just a risk profile and everything. If anyone ever tells you these are guaranteed, like throw the mic away, just kick them up the show. But there's risk with everything. When it comes to this kind of collateralized scenario, you're talking about kind of a very rapid decrease in the price of Bitcoin, for example. And that's where it might be difficult to liquidate the full amount if you're talking about a large amount. So there's a partial loss, for example. Or if the exchange that's holding the Bitcoin gets hacked, that's another risk factor. But ultimately, we have like 30-page documents talking about every risk factor there. Is it still mostly startups and tech companies that are

coming to you as customers? Who's coming to actually earn these yields? Mostly web two companies, which is really nice. People didn't think the market for non-crypto companies, sourcing crypto yields existed. And that's been our kind of bread and butter to date. I guess that surprised to me a little bit, because I would think that during this downturn everywhere, that startups that are much more focused on maybe pausing hiring and derisking would do that with their balance sheet as well. But you're telling me that hasn't been the case. Well, no, I mean, there was certainly withdrawals. We saw a lot of withdrawals when it came to the UST news organically, and rightfully so, by the way, because well, specifically the 3AC news, because lending desks took a lot of losses

there. So we saw a bunch of withdrawals when that took place. What we did was we pulled cash preemptively, from our lending partners until we could see their equity positions. Because we know that the backstops kicked in. We wanted to know how much further equity did they have in case there's another existential leg down, for example. So we actually called customers ahead of time, said, hey, we have your funds in cash. Customers that didn't even withdraw with us. We didn't even give them the choice. We said, look, we'd like to see more of an equity position here. We're going to give you your funds back in the meantime, and just to build trust until the market's kind of settled down. Those thresholds were hit. It went to cash, and you said, we're taking the cash back from those desks.

and you had it sitting there for clients, basically. Those thresholds are for different offerings. So the over collateralized offerings, we still feel very good about. Collateral is king in this environment. The unsecured offerings is when you might run into trouble because you're ultimately dealing with the equity position of your counterparty. Did anything happen in the last few months surprise you? You're pretty knowledgeable about the space and you pay attention to all this stuff

and these different lenders. And even though you're not in business with some of them, you've got to kind of have an understanding. Did anything happen where you go, this got way worse than I thought? Because to me, the biggest thing was just the sheer amount of leverage seems to have just caught a lot of people by surprise, including me personally. When we were talking about me out in 2021, we talked about a hypothetical situation where Bitcoin's price would crash 40%, 50%, intraday, because that happened in March 2020.

I heard you all referenced that in the last podcast episode. You did. When that happened, the most reputable lending desk all stayed fully solvent. So that would be kind of the data point we would tout as to why we believe these yields are mispriced. We couldn't have predicted this specifically, kind of like fraudulent behavior from these giant funds like blowing up overnight. But what we said would happen would happen in that the equity kickers of say parent companies of say like backstops like other companies bailing you out took place. So that part was expected from the perspective of there is a backstop that existed. Now that backstop was exhausted in almost every case here. Now we're in a territory of needing more information.

Now we're in a territory where we don't really have an opinion until we're able to see balance sheets of the lending desk partners, for example. We have no assumptions at this point when it comes to unsecured lending, there's more data that's needed. And I think when that data is provided, if these CFI providers can show they have a healthy balance sheet, then CFI will be back. So when you say these lenders, you're talking about Genesis, for example? Can't speak to anyone by name, just anyone engaging in CFI lending. Do you think going forward that there will be more free flow of information between all these different lending desks, where in the past, they would help their books a little more close to the

chest? Yeah, certainly. I think your last episode was Zach Prince even confirmed that. I definitely see that taking place moving forward. Do you think that there's some nonsense about defy never going down or where do you stand on that on the defy-c-fi debate or conversation, I guess? So over-collateralized defy protocols kind of prove that they work in this stress test. They were the first ones paid back. There's no cronyism. There's no bankruptcy procedures waiting for that. They got paid back first. You could see that on chain. Celsius paying back their loans because they didn't want to get liquidated. Because why, it was auto-liquidated? Exactly, yeah. The collateral would just get liquidated. There's no one you can call in sweet talk

or like no lawyer can send a letter to a defy protocol. But that's for over collateralize. This is very key. Unsecured lending is a totally different ballgame in the crypto world. So talk about it. If I want to lend to you unsecured and you're just an Ethereum address, first of all, who are you? I need an identity associated with you to confirm you are Michael Batnik. That doesn't exist.

Secondly, do you have a credit score on chain or off chain? There's no concept of credit scores. Thirdly, what if you don't pay me back? What's my recourse to you? How do I get a bank or get like a jurisdiction to confirm that Michael Battenham? didn't pay me back and go after him. There's a lot of problems with that. So until we have identity, until we have credit scores, until we have a real way to get recourse against someone who defaults, that's not going to exist on chain. Collateral is king. That's why the over-collateralized

defy protocols work. But the unsecured ones are in their infancy. They don't really exist yet. It's going to be a while. So who are those over-collateralized defy applications? Things like compound, for example. So compound ran like a clock through all this. And it's because you don't necessarily need to know who the counterparty is if they're posting more collateral than they're borrowing from you because you have something of theirs that's inherently more valuable than what you provided them. So is the idea here that, I don't know if you want to call it, smart contractual algorithms or whatever, are kind of better in some ways during a crash than people who are supposedly

doing their homework on their borrowers? I like the transparency of overcollateralized defy protocols that have been like battle tested that have been audited. They get paid back first. This was like empirically the case here. It's not me speculating. It was empirically the case here. There is transparency 24-7 there.

Now, if you talk to a lending desk, you have to go based on their word for the over collateralized stuff, but defy protocols have proved that they actually work and they will liquidate you. Let me see a very basic question. Why are people borrowing and lending cryptocurrencies? Where is the demand coming from? What are people doing with these borrowings? They're low risk in some cases arbitrage opportunities because of how inefficient the crypto markets are. The problem with this is people were taking very directional bets, very speculative directional bets, levering up on things like Bitcoin.

and ETH and SDEth, but there are some low-risk arbitrage opportunities like premiums and futures contracts, for example, dislocations on Bitcoin prices across different exchanges. The exchanges are very fragmented for cryptocurrencies as opposed to traditional equities, for example, which... But I'm guessing that low-hanging fruit that you're talking about, does it limit how much money one can make? And so the people that got into trouble, the people that are reaching for even greater opportunities?

Yeah, I mean, it requires a lot of capital to make meaningful money on like small dislocations, obviously. And yeah, the people who got in trouble were not delta neutral. They were taking very aggressive directional bets. Like 3AC was doing ridiculous things it looks like. Celsius, as I mentioned, like the STE stuff, very aggressive. I can't make sense of it, frankly. Listen, fraud is fraud. And if they were lying, I guess that's tough. How much responsibility is on the people that loaned money to 3AC? What sort of responsibility should they take and not having a better picture? Or they just got lied to it. It's that simple. What were they supposed to do? Where do you come down on that?

It's a good question. It's not an honest. to say they got lied to so it's not their fault. I mean, you need better data. At the end of the day, you have to assume your counterparty is lying to some extent. You need to get like live data. You need to understand the truth of their balance sheet. Maybe get a third party to attest to it. The industry needs to get better in general. We can't just rely on backstops in the future. Do you think without the ability to predict the future and with the understanding that there could be some other macro shock, does it feel like the worst of it is kind of over and that crypto has kind of been cleaned out here for a little bit? I'm not asking you for like a price target

or anything. But I am. Does it feel like, because it was pretty crazy there for a couple of weeks. And there were some crazy rumors going around and this place is blowing up and that place is blowing up. Does it seem like things have at least calmed a little bit and there kind of can get back to normal now? We're certainly massively de-leveraged compared to where we were before. The price has been kind of sideways for something like a month now. The consensus is there doesn't seem to be any more major shoes to drop. That all seems to be the general consensus. And I can tell you, we're already seeing demand to go into unsecured offers. offerings on meow. We're not accepting those right now, just to be clear. But there's a lot of

demand that's creeping back into the space as well from customers, too. This is unanswerable, and it's sort of a shame that this happened when it did, because it would have been really nice to see what cryptocurrencies did during the macro environment of inflation and risk assets selling off. There's no counterfactual. But it seems to be like this, the breakage of Tehrerluna, the collapse of 3AC, unfortunately happened at a time where it was very easy to disqualification. miss the fact that crypto assets could have been a diversifier. And for the record, I think they would have fallen anyhow. But I'd be curious to hear your take on this. Yeah. I mean, if we could control for, I mean, UST was gigantic shockwave and then 3AC even more so, obviously, or as a ripple

effect of it. I'm directionally very bullish things like Bitcoin in a very conservative dollar cost average way. It's just by definition, there's a finite supply of them in a world where we can't control ourselves. We have to print everything to access until we blow up. We have to go be extra mile. That's seen in Limitless where he says, why can't we just crack a beer, live off the interest? Instead, we invade Russia in the winter. But Bitcoin prevents that. How can you not be bullish on that personally? Not financial advice, obviously. Let's talk about this because I am a Bitcoin bull mostly, and maybe this is a cop-up because there's so many people that are bullish. I don't know that I necessarily like ascribe to the

inflation thing, the few thing, because if demand for Bitcoin drives up, it's over. You need people to believe. But where does your belief come from, I guess? It's the only provably finite asset in the galaxy, and it's digital in an increasingly digital world. I think full stop at that point. That's it. Yeah, it's good to be on either side of the IQ curve on this. Like, that's the dumb man's perspective. That's the smart woman's perspective.

It's all the same. There's worse things in the world than investing in a digital cult. And I think it could be a negative connotation, but I think that's part of it. So do you think that the worst actors in this space are going to learn their lesson, taking away the frauds and the Ponzi schemes and stuff? because there was obviously good actors here who made some big mistakes as well. Do you think that the general crypto community is going to kind of learn their lesson and get better because of this? And even if that means you don't see prices go up so much as they did in that short period of time that people are more constructive or conservative, that's better long term. Yeah, if I had to guess, I would say the lending desks are probably taking the most conservative positions they ever have when it comes to who they're lending to, what collateral they're receiving from it, if I had to guess.

What I would also say, what I'd also guess is we don't know the balance sheets of some of these places yet. So I think certainly there's going to be a awakening on risk. There's going to be a totally different night and day perspective on how we approach risk as a community. What kind of collateral we require and what other safeguards we require from our counterparties? Well, you're saying you don't know the balance sheet yet. Are we to assume that they're going to open the books for you? Like, what do you mean exactly? I think Blockfi talked about how they're going to share that with the S1 and all that.

But I think the public's going to see that soon enough. That'll paint a better picture. All right, I guess in closing, who is Meow serving right now? I know we spoke about this, but maybe just a little bit more on that. So mostly corporates or high-networked individuals. So at meow.com, you can sign up. You can talk to us. You can see the different offerings that we have. And you'd have to pick into it by name. So it's not a closed book. It's not like one of those situations where you just have interest account, quote unquote, and you don't know what's going on behind the scenes. You have to actually self-direct. We should have loved with this. Brandon, what is it in your

background that allows you to speak so confidently and definitively about the space? where'd you come from? Well, I don't want to speak definitively about lending markets and things like that. There's no definitive. There's risk reward, just to be clear. But yeah, we're a team of early Gemini engineers, mostly security engineers. That was kind of the founding team here. So we know at least how to build a compliant, secure from a cyber security perspective platform. And then there's risk reward for every offering that you can choose. My last question to you was, so you just raised a bunch of money because you closed your round. What are you doing with it? Are you hiring? Are you shoring up your tech? Are you just having a bunch of

cash in the event that things keep going bad in crypto? What's on the docket for that money? Yeah, so we don't run our own books. There's no like balance sheet risk. There's no duration risk that we incur. We have 20 years of runway right now, which is why we can do kind of frankly like anti-business things, like call our customers and say, hey, we're not going to be earning yield for you on this offering just because we're one percent more sketched out than we were before, for example. So we're just being conservative. We will hire rockstar engineers as they come, but we have no mandate to be aggressive. Now was actually probably not a bad time to hire, right? There's got to be a lot of people looking for jobs at this point. That's true. Yeah. And

think it's going to get a lot worse, frankly, which is tough, but everything's wanting to that, unfortunately. Whoa, whoa, whoa. We've got to end up a positive note. Matthew, delete that. Not only kidding. All right, Brad, this is so much fun. Thank you for coming on. We appreciate your time. Thank you, Michael. Thank you, Ben.