Animal Spirits Podcast - Talk Your Book: The Next Catalyst for Crypto Assets

Starting point is 00:00:00 Today's Animal Spirits, Talk Your Book, is brought to you by Fidelity Digital Assets. Go to Fidelity Digital Assets.com to learn more about their research pieces on all things crypto. And check out their crypto ETFs for Bitcoin, FBTC, and Ethereum FETH. It's Fidelity Digital Assets.com. 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. All opinions expressed by Michael and Ben. are solely their own opinion and do not reflect the opinion of Ridholt's wealth management.

Starting point is 00:00:34 This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Michael, I feel like every time we've talked about crypto for the past few years, you try to come up with a good use case, like title insurance or... or registration for something. You're trying.

Starting point is 00:01:02 I feel like you're a good salesman for the blockchain. You're trying. What if the real thing is just, it ends up slowly integrating with the rails of the financial system. And there is never any consumer use case. And it was just meant to be for financialization. And that's it. Is that enough for you?

Starting point is 00:01:19 Well, it could be. I think long term, long term. Listen, if it's good enough that the banks integrated into what they're doing, I would assume that at some point there's going to be some sort of consumer application, but maybe we don't need it. When I say wait, I don't know why I'm saying way. I'm not, I'm not necessarily from the community, although I support the community. I am a, I'm a Bitcoin at Heath Holder. Chris said about the four year cycle, us holding for four years, we felt for more than four years. I bought my first Bitcoin in June of 2020, I believe. I mean, mine was probably 2017 or so. I did a very small

Starting point is 00:01:57 amount. But the thing is, people would be more concerned about use cases if the price was lower. If the price is high, no one cares about use. Very true. Price being in the 60, whatever thousands now, people would be way more concerned and up in arms if prices were much lower. Well, we've said this in the past. What if for Bitcoin specifically, I think ether's got to be something, there's got to be a there. For Bitcoin, though, it just works, right? It is what it is. It's never been hacked. The blockchain has never, has never been down to the best of my knowledge. It just works. It does what it does. So, uh, On this episode, we get into the history of it, the adoption, what are advisors using it for?

Starting point is 00:02:33 How are they thinking about it? What sort of questions are they asking? ETFs. The ETF, of course. So on today's show, we're joined by Matt Horn. Matt is the head of digital asset strategies at Fidelity Digital Asset Management. We're also joined by Chris Kuyper, Director of Research at Fidelity Digital Assets. Stick around.

Starting point is 00:02:48 Hope you enjoy the show. Chris and Matt, welcome back. Thanks for coming on today. Thanks for having us, guys. pleasure to be back. Yeah, thank you. Okay, I'm going to start the show today with a little story, something that I experienced over the weekend. I took my family to the post office because we needed to get, we needed to get them passports. We're going out of the country in December. And we get there. We're all prepared. We've got our forms. We've got the pictures.

Starting point is 00:03:20 And he says, how long do you want to like expedited shipping or processing? And I said, well, give me what are the options six to eight weeks or my six to eight weeks for okay uh you know six to eight weeks it's fine december's further than that so no big deal uh how would you like to pay uh money order or uh check money order i i what what is a money order i have no idea i didn't have a check so i said yeah let's go with the money order um okay so he punches me up two hundred thirty seven dollars i take up my credit card go to tap up sorry we only take debit cards you only take debit cards for a money order? What even year is this? So, I don't know, he printed the money card, the debit card, the this, the that. Okay, obviously there's,

Starting point is 00:04:06 there's inefficiencies here. This is the government. We understand how that works. Is blockchain not a solution for these sort of financial transactions? And if so, what are we talking here? Like, what would fix the money order nonsense? Well, I mean, I don't think you need a blockchain to fix that in that instance. But, you know, I think there are a lot of unique use cases for blockchain technology, and they're becoming more apparent over time. In your instance, there, Michael, obviously, you know, just the ability to accept traditional payment rails in the modern era would have worked. But, you know, really with blockchain, you know, we're quite a ways into this now, right? Bitcoin came around 2009, Ethereum 2014, 2015.

Starting point is 00:04:47 And you've seen a lot of different use cases being built, you know, more recently on top of these protocols. And it does get pretty interesting as to what you can, you know, predict a future state to be using this technology. People generally say, you know, what is the killer app for crypto at this point? And I'd argue there's many, but, you know, I think the most common one you would hear is around stable coins, right? The ability to take a fiat currency, U.S. dollar, put it on blockchain, digitize it, make it instantly transferable globally as a digital bear instrument, right? It's like handing a dollar to a person globally instantly, right? The issue there, of course, is, you know, the inability of a stable coin to generate a yield. So there's sort of an opportunity cost by keeping your money and stable coins in a higher rate environment.

Starting point is 00:05:35 So now we're seeing the proliferation of things like tokenized money market funds that are trying to solve that use case. I saw Circle, somebody tweeted Circle made more money last year in the Goldman Sachs or last quarter or something. I believe it was Tether in a circle. Oh, Tether. That's right. to your point, there's a 5% available and they're not paying it out. But it is kind of funny that we're however many years in, the white paper was, I don't know, 2009 or something. And Bitcoin and Ether, which we're going to spend the majority of the conversation today talking

Starting point is 00:06:03 about, have become legitimate asset classes. But Matt, as you mentioned, really the killer use case today are stable coins, which I don't know if it's ironic or what the right word is, but it's kind of funny. Well, I want to talk about stable coins a little bit because I made the corollary a few years ago that like stable, it's kind of like a money market but also a currency hedger. How would you explain it to people who are unaware of how they work? You're getting the benefit of a currency you want like the US dollar, but you're getting it on the blockchain rail. So you can do all the stuff you can do on blockchain, but you're using a US dollar rather than something else that you might not want to be exposed to like the volatility of Bitcoin

Starting point is 00:06:41 or ether or something like that. And so, of course, there's that aspect of it. You've opened up anyone with an internet connection, especially to your point, Ben, I was a little surprised at the rise of stable coin, but that's probably my myopic view as a citizen of developed world. But you get into this and you start to see how important these things are in developing worlds for people to have access to them. It's like an instant bank account access or a way to get dollars where they might be banned or very hard to get. And then, of course, you have all the technological benefits of it. It removes so many frictions. You can verify stuff much easier to Michael's point. It's not going to take days and weeks for this stuff to clear. It's almost

Starting point is 00:07:27 instantaneous. Do we know? So that makes a lot of sense. Listen, we're U.S. citizens. We have the strongest currency in the world. We don't necessarily need stable coins. Like what we have works pretty fine. Yeah, it could be better, I suppose, but it works pretty fine. Do we know how much of the stable coins outstanding are held overseas? Because if you tell me that 92% of stable coins are held by Americans, well, then what are we doing here? It's definitely the majority is offshore, without a doubt. It's because, again, to Chris's point, we're the most developed nation. We don't need it, right? But if you think about the emerging worlds, you know, the emerging world was sort of able, because they weren't the leading edge of technology adoption for the last 50 years here,

Starting point is 00:08:09 they were able to kind of skip some of the things we went through here in the U.S., the landline phone, right, the dial-up internet. It kind of went right to cellular. So technology is now global in the palm of one's hand. And this technology now makes the ability to transfer value instantaneously with, you know, finite settlements, you know, settlement assurances, the inability to easily counterfeit, you know, this currency. So it is attractive in many ways because for better or worse, the dollar still is the global currency for most nations, right? That's sort of what you go to travel anywhere, Michael, right, with your fresh new passport you're going to have anywhere you go, they'll likely take the dollar, right, even if you don't have the

Starting point is 00:08:51 local currency. And a stable coin is just a manifestation of this, of a tech, you know, just a current technology version of the dollar essentially, right? Now, why is it interesting, right? You know, in a world of low interest rates five, six years ago, stable coins proliferated. And but as rates rose, there was an opportunity cost then, right? Because if you were a crypto native firm or stable coin user storing your value in a stable coin and having to sit there, you are missing out on anywhere from three to five percent yield. And I think that's why we've seen such a move here to find yield generating instruments that one can now hold in a similar vein.

Starting point is 00:09:29 And that's your point earlier. That's why these stable coin issuers for years have been making a very fat margin because they've been able to not pay a yield on a stable coin while investing the collateral, the dollars, right, in U.S. Treasury's at, you know, three to five percent. Unless you live outside the United States and your currency is weakened significantly against the dollar, then who cares about the 5 percent? Fair enough.

Starting point is 00:09:47 Yeah. There obviously is the purchasing power parity type narrative there for sure. But, you know, cedrus, peribus, whatever, all is equal, right? You know, I think the opportunity cost of yield is where I see a lot of institutional players, right, that are operating on chain, trading firms, crypto-native hedge funds, crypto-native firms that just keep a lot of their reserves or balance sheet on-chain. they saw a massive opportunity cost there, and there was demand for yield on chain, and hence the developments we're seeing with, you know, yield generating instruments.

Starting point is 00:10:17 All right, so let's get back to Bitcoin and Ether. It's been an exciting year for the two asset classes. The Bitcoin ETF, did it launch in January? January 11th. Okay. And Ether was June? When was it? Late July, July 23rd, I think it was.

Starting point is 00:10:32 Okay. And it's been a raging success, at least Bitcoin has. We'll get to Ether in a minute. But are you guys surprised at A, the amount of flows into the Bitcoin ETFs? And are you also surprised that it hasn't led to substantially higher prices? Bitcoin's been acting well better in the past week or, you know, a couple of weeks. But overall, it's been there's been, yes, there was a huge runup, but there's been a lot of sideways action for the last couple of months.

Starting point is 00:10:58 For sure. Yeah. So it's your first question. The flows were definitely a pleasant surprise, I would say generally. I think it was very hard to handicap this category coming out. as to what the demand would be because you had existing assets tied up in legacy products that were converting into the ETP structure. You had, you know, I think it was 10 or 11 issuers launching all in the same day. So there was, again, a lot going on. But all in all, I would say

Starting point is 00:11:23 this was a smash hit home run success for a new ETF category being Bitcoin. Very strong adoption across all client segments. You know, I see a retail still leading the way for the most part, advisors coming in strong over time here, right, as they make their assessments and do the due diligence. And last but not least, we're seeing, you know, earlier adopters via, you know, the institutional channel using these ETPs. On the Bitcoin side, the one, I say, interesting development that really caught me by surprise was just the traditional hedge fund usage of these products. You look at, you know, some of the top products in the category, including FDETC products and in a decent amount of hedge fund.

Starting point is 00:12:05 ownership and they're using the exposure in a variety of different ways. Because they're in the ETP structure, you know, they play easier in the traditional financial system, meaning, you know, they're marginal. There's a, there's an arbitrage trade going on for some of these hedge funds where they're buying the spot, Bitcoin, ETP, selling forward the CME futures and locking in arbitrage trade there. So I would say, you know, the institutionalization of these ETPs was one of the more shocking things to me this early. How does it impact when we see? options and some other activity on top of these ETFs. Does that make a difference at all? It could. And, you know, it's hard to say exactly how options on the Bitcoin ETPs will play

Starting point is 00:12:45 out over time. I think it's great because it just gives participants another instrument to hedge or do various trades in the long run. They just got approved, right? The Bitcoin ETF options. No, there's a process here. They're not finally, not approved. It was one leg in the process, but, you know, we're optimistic for hopefully working with regulators and the exchanges for some time next year. But again, it'll be another tool in the tool chest here for market participants to use to put on either positive or negative exposures toward the asset class. Ethereum I'd say a little bit earlier on the adoption curve. I'd say that's not expected. Now, as an ETF category, right, the Ethereum, by all means, again, a smash hit, right? You're seeing, I think,

Starting point is 00:13:29 well over $2 billion in gross flows into the new products in the category. Obviously, there was one existing product that has outflow, so it's sort of a muted kind of net flow. But overall, for a new ETP category, $2 billion in a month and a half, whatever it's been, is a smash hit home run. Now, Ether, and I've been in crypto personally since 2016, 2017, and professionally for five years now. And in my opinion, it always starts with Bitcoin. So it's no surprise Bitcoin has the majority of the focus of the ETP flow in Ethereum. is coming on now. Ethereum, we can get into this a bit more.

Starting point is 00:14:07 It's a much different use case. There's a lot more going on. There's different narratives playing out around Ethereum. It's definitely, it's a bit more dynamic, I'd say, as a protocol than Bitcoin. And it just takes time to understand. And I think, frankly, advisors and institutional participants have enough time, have enough on their hands to figure out how do I deal with Bitcoin, never mind Ethereum, right? So it sort of is an adoption curve of not just digital.

Starting point is 00:14:34 assets, but even within the digital asset system, you know, Bitcoin generally goes first, Ethereum comes second. So I'm not shocked to see this lagging. Michael and I have talked a lot about the narrative and right or wrong that drives flows and interests for a lot of people. And we always said Bitcoin, the selling points for Bitcoin ETF are pretty simple. It's digital gold ETF, basically, right? Whether you believe that or not, that was a good selling point. It's a lot harder to pin down the Ethereum. So, Chris, how do you explain the Ethereum use case or investment case or whatever it is, if you wanted to make it simple for someone who doesn't understand how all this blockchain stuff actually works. Yeah, like you said, we view them very

Starting point is 00:15:10 differently. Bitcoin's kind of its own asset class, either if you want to talk about it like a commodity or like a non-sovereign currency that people are adopting. And the investment thesis is very clear there. It's something that's non-sovereign has a finite amount. And it's the most decentralized one out there, market share leading, all of those things. And then Ethereum, people used to lump them together, and now I think they're beginning to see that they're very different. And to be fair, they started a lot more similar. They were both proof of work consensus mechanisms, and we can talk about that. But Ethereum has undergone all of these changes and all of these upgrades. And so it's a very different asset class. And so the way I would think about it is

Starting point is 00:15:53 you have Ethereum the network, just like you have Bitcoin, the network. And it's all the computers running the Ethereum code, they're following the rules, they're processing these transactions, these things called smart contracts, which are little snippets of code that have to be run to make these decentralized applications built on it work. And then you have Ether, which is the native token to the Ethereum network. So this term gets thrown around a lot. We say Ethereum's trading at $2,600, whatever. What we actually mean is the Ether token. And the important thing to note is it's a purely digital token. You can hold it. You can send it to others just like Bitcoin. It's not controlled by government. It's got its own

Starting point is 00:16:33 issuance rule set. But the key difference is you need that ether token to pay for computation on this network. So all these applications built on the Ethereum network, they have to run on the network. That takes computational resources. And so you have to pay your way with the native ether token. So from an investment thesis perspective, if you're going to invest in ether the token, And especially if you're just going to hold it, what you're betting on or investing in is this network getting bigger, more stuff getting built on it, more users coming to it. And therefore, people need to buy the token and hold it to do all these transactions on it and to run these computations and these decentralized applications on it.

Starting point is 00:17:15 And fundamentally, every blockchain is tradeoffs, right? It's sort of like tradeoff between security and throughput. And how you want to optimize on that is sort of up to the community that's supporting that blockchain. And, you know, back to, you know, Ben's point, you know, the Bitcoin is the Bitcoin blockchain is pretty straightforward. You know, it doesn't change very often. It's slow to move. It's sort of ossified at this level for its use case and it's doing exactly what it's designed to do very well. Ethereum has had a lot of changes over time and is very different and aspirational what it's trying to do. So right now and Chris, I love your thoughts on this too. This sort of is

Starting point is 00:17:55 a battle for how to best optimize the block space, right? There's a finite amount of block space on Ethereum. There's layer twos that try to optimize some of that, you know, real estate on the block space. And, you know, how do this community come together and optimize that for the best outcome for Ethereum? And I think it does get complicated for, you know, the average person to approach and try to understand what's going on. I'm in this space and it's a lot to follow, frankly, right? So never mind, a financial advisor or someone who's trying to understand how will value accrued with ether over time. And to Chris's point, fundamentally, as there's more demand to use the Ethereum blockchain for whatever purpose it is, right? There's many purposes and use

Starting point is 00:18:35 cases you can use it for. As there's demand to use it and spend Ethereum, right, then the value of ether should go up over time. So that's sort of the general North Star is that this is a very useful blockchain. There's a lot of useful actions and activities being done on this chain. And people want to hold and use ether in this ecosystem. And that's fundamentally the driving force here. Yeah, I'll throw two. Are stable coins? Sorry, Chris. I'll just throw two analogies and I'll get to your question there because one is you can think of Ethereum like an app store. It says this platform and then people build apps on top of it. And so if you think people are going to build more apps and more people are going to come to this app store and use these apps, the tokenomics say, or that's

Starting point is 00:19:16 the idea that the value of ether should go up. So that's one way to think about it. It's this blank canvas. Anyone can build all this stuff, but you got to pay your way with this ether token. What about stable coins? Are they primarily built on top of the Ethereum blockchain? Yes, Ethereum has a majority of the stable coin market. There are other competing networks that are taking some as well, you know, a stable coin. And one stable coin can operate on multiple blockchains as well.

Starting point is 00:19:45 I'm not even going to dig deeper into that because that sounds like a worm. All right, go ahead. So what is ETH being used for? we just released a report, Max Waddington on my team, a very sharp guy when it comes to Ethereum. It talks more about the investment use case and he goes through the stats on what is ETH used for. The number one, 34% of all ETH activities is just ETH transfers. So just like the Bitcoin network transferring ether from one wallet to another. Stable coins is at 12%. Decentralized finance applications are 13%. ERC 20 tokens. So these are different tokens,

Starting point is 00:20:21 Now native tokens are 14%. And then the rest of the bucket is 27% of all other things. It seems to me that a lot of this tokenization stuff, maybe this is just the point. It's just there's a lot of, it's all financialization. It's a lot of swapping. It's a lot of back and forth. I don't know if this is a criticism, but I think that a lot of people outside the crypto ecosystem would say, well, what is it for?

Starting point is 00:20:46 Like, is it going to ever do anything other than just be a financial instrument? Is there going to be a consumer application? Does there need to be a consumer application? Well, I think there's two ways to think about. Number one is, yes, I agree with you. Most of the activity, the things I just ran through are financial nature. So, eth transfers, if you're transferring value, I would say that's financial. Decentralized finance, that's obviously financial.

Starting point is 00:21:09 Yeah, you're swapping assets. That's financial too. So that other category, 27%, you've got things in there like gaming, collectibles, NFTs, social apps, that is there, but it's smaller. So you bring up a great question of, does Ethereum move beyond just financial applications, or is this going to be its continued use case? But I would say there are and there will continue to be consumer applications on these things. You've already seen it. There's obviously a need for consumers to do financial things in a much more frictionless or efficient way.

Starting point is 00:21:47 And especially if you're not in the U.S. where you already have, you know, a lot of great apps and companies and things like that. One potential use case that I haven't seen like proliferate yet, maybe I'm just making this up. So check me from wrong. Michael's an ideas guy when it comes to crypto. Yeah, I'm just throwing some getting against the wall.

Starting point is 00:22:03 See what sticks. Like live events. I've been to a million Nick games. And guess how many, guess if you asked me to pull up a record of was I at that game, have I seen this player? I don't know. I have no idea.

Starting point is 00:22:16 Like, what about just NFTs for concerts, for sport, for sporting events, for reservations, things like that? I think it's funny you said that. I heard someone talking about this the other day where they said, the good old days of concerts where you had the concert stub. You'd say, I was at that concert, you know, whatever, grateful dead and whatever, right? I think that's interesting. Why not, right? I do think, absolutely, these blockchains are ledgers. They record data and keep it in a decentralized location for history, right?

Starting point is 00:22:45 And so I absolutely think you could do something like that where you had an NFT that shows you were at some event, right? I think that's interesting, right? You had the game six of the Knicks playoff game or whatever, right? I think that would be an interesting use case. So the current use cases for investors now, if they're in the ETF, I'm curious how you see people using, if they're using both ETFs, because I'm not sure the latest breakdown, what is it? Maybe if you broke down Bitcoin and Ether market caps, it's 8020. Is that right? Close or not really?

Starting point is 00:23:13 Of the market you have of Bitcoin and Eith? Yeah, Bitcoin versus Eith. I'm saying if it's just the two of them. It's like 70.30, roughly, give or take. Okay, 70.30. So I'm curious if you see anyone, if you see a lot of investors that hold both ETFs doing that, do you see a lot of people trying to get those similar? Or is Bitcoin still just a much bigger piece in most people's portfolios if they're using the ETFs?

Starting point is 00:23:34 Yeah, without a doubt, it is Bitcoin is the majority of that position, right? I would argue, you know, 90% of the digital asset ETP. that are held out there, they're just holding, you know, mostly just Bitcoin. Now, there is an early curve of adoption, I'd say, especially in retail side, but some advisors we're seeing now to come in to get the Ethereum exposure. And generally speaking, they're not doing either or they're holding both. They're not going to sell Bitcoin to buy Ethereum. They're just going to hold both generally in the market cap proportions, like I said. If you look at the total market cap of Bitcoin and Ethereum together, right? Roughly 70% of that market cap is made up by

Starting point is 00:24:11 Bitcoin, 30% is Ethereum, give or take. And you're seeing some similar pro rata allocation to portfolios that way. Now, those that are buying both, I would say generally understand there are distinct narratives here between the Bitcoin story and then the Ethereum story, which we kind of hit on a few minutes ago. Bitcoin comes first, right? That's the non-sovereign digital store value. You know, in the narrative, honestly, we're hearing in the field talking to advisors and different institutional investors is, you know, they're looking at just the central bank,

Starting point is 00:24:41 largest globally. The Fed's back to cutting rates again. We're paying trillions on a year on interest payments now. So I do think there is a cohort of advisors and investors who just generally want to potentially hedge some of that a little bit, right? And they look at things like gold, which is at an all-time high in Bitcoin as a way to do that. So I think that's sort of where they start out. Ethereum, this is where I think firms like Fidelity can help out, you know, our clients, really well because we have the resources to spend time focused on doing research in this space on Bitcoin and Ethereum, writing papers, having the availability of client strategists to do calls with and understand this because it is complicated. And for an advisor with limited time and

Starting point is 00:25:28 resources to sit there and try to navigate this new asset class, it's so hard. But when you when you guys are talking to advisors, at least let's start with Bitcoin, are they are they asking questions like, hey, get me up to speed on Bitcoin. How do I talk to clients about it? Or do they mostly understand? It's not super complicated. And they're like, all right, well, why Fidelity versus some of your competitors? So some of the conversations are right there, Michael, right?

Starting point is 00:25:52 They're at the finish line. They want to allocate to just trying to figure out which firm to use, right? Which partner to partner with? All right. So what's the pitch? Well, Fidelity's been in the space well over a decade. We have a long history of, you know, participating in the digital asset ecosystem. We began with mining Bitcoin as far back as 2014.

Starting point is 00:26:12 And as a result of those mining activities, we had to build their own custody. So we built their own custody solution, which we now offer to advisors and institutional clients. It also powers our retail digital asset offering. So point being is we understand this technology really better than any firm would argue in the space because we've had to participate in it for much longer. And we've built out numerous different technology plans. platforms to support our business in the space. We now offer two commercial offerings. We have direct custody with Fidelity Digital Assets Services. So if you're an institution or an advisor,

Starting point is 00:26:48 you can come directly to us with your Bitcoin or Ethereum. In custody, it's safely with us. As an advisor, that could be a potential option that could work well because you can integrate these digital assets alongside traditional assets. So if a client has, if a client has their Bitcoin at, I don't know, say Coinbase, for example, but the advisor, the rest of their, the rest of their money is at Fidelity, and they want to see Bitcoin within the context of their whole portfolio, they can move it and custody it with you guys. Correct. Yeah.

Starting point is 00:27:18 And it's going to depend on, you know, again, how it's held and what state they're in. But generally speaking, there is a solution there that it's worth engaging us with because that's the biggest pain point. You can be an advisor sitting, you know, wherever. And you know you have a client who might have millions of dollars at Coinbase because they bought Bitcoin or Ethereum back in 2015. And the client had never been able to bring it over. They don't want to sell because of tax basis.

Starting point is 00:27:41 And the advisor just knows it exists out there and they can't see it. So now at least the advisor can holistically bring it under the umbrella on platform and advise on it in a more cohesive manner versus just kind of ignoring it. And the second commercial offering we have, obviously, is a Fidelity Digital Asset Management, where I work. And we have the Bitcoin and Ethereum exchange trade products. So FBTC is the Fidelity Bitcoin products in FETH is our Ethereum ETP, both 25 basis points. Ethereum is waived for zero feet until end of year, but great liquid options to access these asset classes in a holistic manner for any account type, any registration type, on or off Fidelity's platform.

Starting point is 00:28:22 So we try to bring the best of fidelity to our clients, give them actual solutions here where we can meet them where they are, whether they want to go direct to our custody platform, like I mentioned before, or enter the space with us in a very familiar vehicle like these ETPs. So many ways to access these assets with us. And one of your recent research pieces, your team lays out the compound annual growth rates for Bitcoin and Ethereum for the last four years. And it goes from, I think, May 2020 to May 24. And the numbers are insane, higher than I would have thought. I guess caveat is that was coming from a low base because of the pandemic and such.

Starting point is 00:28:58 But Bitcoin is up 65% per year. Ethereum is up over 100% per year. And you show the previous four years as well, which are both 100% per year. I'm curious how you go about setting expectations for these asset classes and these funds. Do you kind of say, listen, returns should be lower, but volatility should be lower too over time as they mature? How do you position these from an expectations perspective? Yeah, there's a few schools of thought here. One is, and you'll see these in our research reports, We note how volatility for both have gone down. So the numbers you just mentioned are from that most recent report.

Starting point is 00:29:34 We just released it a week or two ago called how Ether may add value to a portfolio. And in that report, we also show volatility, just draw a regression line through them. They're both declining. So as these assets get bigger, volatility has gone down as we get more financial products around it, like exchange traded products, like options. You would expect volatility to be mitigated as well. Of course, the big question is, do you get deep? decreasing returns as well. Now, of course, these things, you know, trees don't grow to the heavens or whatever the saying is, these things can't overtake all, everything in the world. At some point, you are going to hit that law of large numbers. So it would be foolish to think you'd get those absolutely fantastical gains like we have before. But that doesn't mean if you just do some simple total addressable market analysis of what what markets you think these things could capture, they're still very high, right? If you think it could take X percent,

Starting point is 00:30:28 of gold or other commodities, X percent of other things that contain monetary premiums or other technologies out there. You could still get some pretty juicy numbers. And of course, the thing we try to drive home is, yes, they're volatile, but they have these high returns. So just looking at simple historical stuff when we do this in that same table, you're well compensated for that risk. Your sharp ratio is higher. Your certino ratio, which only looks at the downside deviations, which is what most investors care about. They don't care if something's volatile to the upside. They care if it's volatility of the downside. Those are all higher than your traditional asset classes. And then we go through why and how this could make sense as part of your portfolio.

Starting point is 00:31:06 The way I approach it, Ben, is a non-zero position could make sense if you think it makes sense for your client's portfolio. You manage the volatility through position sizing, right? So most advisors, I generally say, are probably allocating one to three percent somewhere in that range at most, right, for some of these digital asset exposures. And, you know, you can manage volatility around that. You can set client expectations around that, just knowing everyone knows it's going to be volatile at this point, I would argue. And you have to have a long-term time horizon. And there's going to be years where those gains aren't there. And we know that. But if you have a consistent exposure to it, you allocate it to it consistently, you know,

Starting point is 00:31:45 rebalance at some point. It should, you know, prove out over time, assuming those returns carry forward. I would argue that the rebalancing piece is probably the biggest one. Like even if, let's say the returns are way lower going forward, but the volatility is still really high. I would argue what I think Cliff has instead of AQR had a recent piece about this. He talked about the benefits of adding a high volatility asset to a portfolio. And I would argue that the rebalancing piece is even more important going forward for that if the volatility is so much higher. So here's my big question, as a target date fund guy, how far away are we from these being in target date funds? Because that would make a lot of sense to me with an automatic

Starting point is 00:32:23 rebalance that takes sort of the decision out of people's hands. Yeah, I'd say we're still ways away. I think this is challenged there in general. And this isn't just like a fidelity issue. I think it's just a general institutional investor issue where it's limited history. It's hard to model capital market assumptions going forward in a thoughtful manner. The Department of Labor would have something to say about that. Like putting that in like four and one K plans. There's that consideration too, right, as far as oversight. You're saying like a 2% Bitcoin or I say 2% crypto piece in a target date fund. You think people would have a problem with that? I don't think, I think the government would.

Starting point is 00:32:58 Yeah, I can't really comment on that. But I just think just from a portfolio kind of intellect standpoint, Ben, just even also I'd say, you know, we're just at the point now where all it's are proliferating, right? And I think the index is most people use for benchmarks in the general alts category, go back to like 2002. I think people are just getting comfortable kind of using those as reference benchmarks. So again, limited history, Bitcoin was first. And most would argue 2015 is the year you want to look at trading data.

Starting point is 00:33:26 for Bitcoin, just given the volume, and pre that year, there wasn't enough liquidity. So you're really not even 10 years into a price history for Bitcoin that's acceptable, you know, for most institutional allocators. Now, some get over that quickly, right? They understand the thesis and they understand you just don't have it. You've got to just make an assumption based off that. And that's where Chris was sitting on with what do we think this could be, right? You look at other modeling techniques there.

Starting point is 00:33:51 So I do think the lack of history is sort of an impediment to some of these, you know, bigger mandates that we're talking about, whether it's target aid or just institutional adoption here. As we think about the next catalyst, I think the obvious one that crypto folks would say is the having. Chris, can you talk about just remind people what that is and why that might be a positive catalyst for the asset class? So the halving is what occurs in the Bitcoin network approximately every four years where new Bitcoin are issued every 10 minutes and they go to these people called miners who are helping to secure the network. That's their reward for spending all this electricity and computing power. And that reward gets cut in

Starting point is 00:34:31 half approximately every four years. So the issuance schedule of Bitcoin, it increases a lot. And then every four years, that slope is getting shallower and shallower. So this is why we've got 19.6 million Bitcoin out there already. We're not going to hit that near 21 million limit of Bitcoin until the year 2140. That is what is embedded in the code. So from one perspective, people look at the supply side of this, and they say, every time there's a halving, there's fewer and fewer new bitcoins being minted. And so all else equal. If demand stays the same, then that has to be expressed, that change has to be expressed

Starting point is 00:35:11 in a higher price because there's fewer new bitcoins coming onto the market. There's, of course, a lot of debate around this. Maybe some people think that having had a lot of weight or influence early on because you went from 50 Bitcoin every 10 minutes to 25 to 12.5. And now, of course, if you just look at the numbers, it's a lot fewer or fewer Bitcoin every time you get a having. So I'm not exactly sure. These four-year cycles also align with other things like Fed liquidity cycles or election cycles. So we can't, we don't have a good experiment to rerun on these things. And so there's a lot of debate whether or not that's actually driving the price or if it's other stuff.

Starting point is 00:35:53 Last question for me. I'm sure you guys have done work on where the Bitcoin is coming from, how many Bitcoin are in the ETFs. I'd be curious, who do you think the sellers are? People in the Bitcoin community feel very passionately about their Bitcoin. They don't let it go very easily. But with you can fill in the number, how many billions of net flows into the category, how many are held by ETFs? They've got to be coming from somewhere. So what's your best guess into where these coins are coming from? So because of the on-chain nature of this, we can see some things. we have some visibility. And one of the things we have seen with the recent run-up in price and former run-ups and price, this is nothing new with each cycle, some of these very long-term holders start to liquidate their coins. So if you've got someone that's been holding it since 2012, 2013 or something, eventually, for whatever reason, they want to sell some of it. They want to buy something. They want to rebalance whatever the case may be. Everyone reaches a point where where they, at that marginal price, they're willing to let go of some of their Bitcoin,

Starting point is 00:36:56 whereas to what you allude to, there's still some very ardent people who say they're never going to sell it, or maybe they're newer to the space. And so they're planning on holding it many more decades yet. And so that's what makes a market, right? All these different time preferences, different liquidity preferences. But we can actually see some of that movement happen on chain, which is very interesting. Every time a bull market starts to take off, Michael and I have a discussion about what price we would be willing to sell some of our Bitcoin. And I think we just keep moving the gold posts, right? Well, you know what?

Starting point is 00:37:26 I feel like we haven't, I haven't sat through that 70 plus percent drawdown just to get back to even. You know what I mean? Yeah. Like just to get back to the all time. You got to do your four year tour of duty yet, right? Exactly. But I think we had this, maybe this discussion last time, where what's interesting about Bitcoin, and I come from a traditional finance background and equity analysts. And I read, of course, a lot of value investor stuff.

Starting point is 00:37:52 If you look at, say, something like a stock and you think the intrinsic value is here and it's trading out a 50% discount, that's your thesis. And then, of course, you want to get in on that thesis before other people realize the intrinsic value. You get in, other people start to realize that the price goes up. So as the price goes up, your thesis is getting validated. But then your risk is also going up because now you're closer to your intrinsic value, right? So you want to then close out the trade once you think it's reached its full potential. The weird thing about Bitcoin is as the price goes up, the more it's validating its thesis as this aspiring form of money, aspiring store of value.

Starting point is 00:38:32 So your risk is getting lowered as it goes up. People who bought Bitcoin at 10 cents were taking on way more risk than people buying it at 1,000 and 10,000 because it's validated its thesis more and more along the way. There's nothing else like that. There's nothing else like that. It's a totally different mindset. It's exactly right. Yeah.

Starting point is 00:38:50 All right, I think that's a great place to leave it. Chris and Matt, this is great. Thank you for coming on. For people that want to learn more about Fidelity, digital asset management, where do we send them? Yeah, so for advisors, go to institutional.fidelity.com. You can check out FBTC and Fetheth there as well as some of the direct solutions I talked about. And for Chris's research, Fidelity Digital Assets.com. Thanks, guys.

Starting point is 00:39:10 Thank you. Okay, thanks to Matt. Thanks to Chris. Thanks to Fidelity Digital Assets. Go to Fidelity Digital Assets.com. For more, email us Animal Spirits at the CompoundNews.com.

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Animal Spirits Podcast - Talk Your Book: The Next Catalyst for Crypto Assets

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