Odd Lots - Sam Bankman-Fried and Matt Levine on How to Make Money in Crypto

Episode Date: April 25, 2022

The price of major cryptocurrencies like Bitcoin and Ethereum have been moving sideways for awhile. But it doesn't seem like there's any slowdown in terms of money entering the space. Every day, some new fund is being launched or some legacy financial institution is diving into it. But what's all this money going to do? On this episode we speak with Sam Bankman-Fried, the CEO and co-founder of FTX, as well as Bloomberg Opinion columnist, Matt Levine, the money making opportunities that people are exploiting, whether it's directional bets on coins or yield farming or arbitrage, and how much potential profit there is for the taking. See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a big line. It's a lot. It's a firm. commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad

of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk,

Vanguard Marketing Corporation distributor. If Bellfib TV is now streaming? Is it still TV? Is it still TV if there's no TV box? If I can stream all my favorite channels and pause and record shows, that's TV, right? A new era of FibTV. It's streaming,

but it's still TV. Well, glad that's settled. Bell, connection is everything. And welcome to another episode of the Odd Lots, I'm Joe Weissenthal. And I'm Tracy Alloey. Tracy, the coins. Time to talk about the coins again.

The coins? Yeah. You mean like, you know, Fiat coins, right? No, the electronic digital coins. Ah, okay. You know what? It feels like it's been a while, hasn't it? Well, so this is the crazy thing.

This is my, like, what makes crypto difficult for me, which is that if you like, and I've said, maybe you said this before, but if you step away from you, for like a month and you like focus on other stuff, like the price of corn or wheat or oil or something. Russia's invasion of Ukraine. Yeah. And then you come back to crypto and it's like the entire narrative has completely changed. There's all this new terminology, new tokens that you've never heard of. Like you can't step away for a for a minute, let alone a month and feel like you have any sort of hope of understanding what's going on. It does feel like it requires a certain intensity to make it in crypto. And then after that month, it's like, well, I'm already so much.

I don't want to come back. I actually know you're like four months behind. So we have to reverse it. We have to catch back up with less going on. Yeah, we need to reverse that. I mean, I am vaguely aware of some of the big picture stuff that has been happening. So I'm looking at the price of Bitcoin at the moment. It's just under 40,000.

It is weird. And I think you wrote about this. It is kind of strange that in this environment, Bitcoin hasn't been doing better. I know. So, you know, here's what I've been thinking about, which is that the prices, especially the big ones, you know, there's always token. and it's going to the moon, but the prices of like the big ones, overall market cap, rough year, kind of gone sideways in the last year or more down.

But the interest in the space continues to be unabated, and it feels like every day someone is leaving a big bang, a big fund to do something new in crypto hedge fund, crypto VC. Interest in investing in the space does not seem to have abated at all, even with the price of big coins side of going sideways to down. No, absolutely. And also, the other thing that sort of happened is rather than crypto going off and being its own ecosystem, which if you think back to Bitcoin and its origins, that was really kind of the point of the whole thing. But it feels like crypto as a whole is becoming more and more integrated with the existing financial system, or at least with Wall Street. And so, you know, you see people who are collecting NFTs and now they're talking about the bond market and interest rates, which is kind of funny. But you're right. We haven't spoken about it for a while. we should definitely rectify that. So I want to know basically what all this new money entering the space is doing. And something I've been thinking about is that in 2018, you could make a fortune essentially

just buying Bitcoin or maybe 2017, 2018, buying Bitcoin in the U.S. and selling it in Japan because the market was so inefficient that there were like multiple prices around the world. And you could make a ton of money doing that. These days, I suspect that the market is vastly more. efficient than it was back then. On the flip side, I also get the impression that compared to Tradfide, that the spreads are still a mile wide, and that there's still big opportunities for all this money coming into the space. So I'm very, let's have a conversation about how to make

money in crypto. Let's do it. All right. I'm really excited we're going to be bringing back into his third time on the show, the one and only Sam Baintenfried SBF. He's the co-founder of FtX. and we're also going to be joined by Matt Levine, Bloomberg Opinion columnist. We had them both on last fall. Everyone liked hearing them discuss the state of the markets together. So we figured let's have them both back on. So Sam and Matt, thanks to both of you for coming back on Oddlots. Of course.

Thanks for having me back. Absolutely. So, Sam, let's start with you. Actually, you guys have a big conference coming up at the end of April, the FTX Salt Conference, crypto Bahamas, the Bahamas being your new corporate home, which sounds pretty nice. Am I basically right that there is still this huge essential tidal wave of money coming into the space? How would you characterize very big picture all the interest right now in crypto?

There's a huge tidal wave of money trying to come into the space, is what I would say. I like that. You know, gobs and gobs of it. that that sort of been has been desperately, you know, sort of like trying to like find its way in over the last few years every month. Another sort of like nice little pile of that, of that, you know, larger gob manages to make it in. So one thing I saw recently is that you took a stake in IEX, which I think a lot of people will recognize as the firm that was founded by Brad Katziyama, who's the guy who was,

written about in Michael Lewis's book Flash Boys all about the evils of high frequency trading and stuff like that. What exactly is the thinking there? And, you know, I guess I understand some of the maybe the ideological alignment or the stated ideological alignment there, but what exactly are you going to be doing together? Yeah. And, you know, obviously we'll have to see what happens because this is, you know, highly regulatory-dependent space. But, But the core of it is like some digital assets are securities. Different people might give different quotes for exactly which fraction of them are, but certainly some fraction of them are.

Let's say that you want to offer trading in a digital asset security. What would you do? Right now, this is not a problem that people have really confident regulatory solutions for. It's something that there's certainly a lot of thought going into from the regulatory perspective. You know, at its score, like we're experts in, you know, things to do with, with tokens and offering trading in tokens. IX are, you know, experts in offering trading and securities. And more generally, they're also really good at being creative and sort of building out new market structures. That might not be exactly the same as what, what they're sort of used to doing.

And that's exactly what we need to do right now is to build out a new market structure that is consistent with our existing, you know, rules and regulations. in coordination with the SECA and other regulators for digital asset securities. And that is our big deal with them. Something you said, Sam, in your first answer, I thought it was really interesting. You said there's all this money and it tries to get into this space, which I sort of took to me and there's like some constraint or that it's not easy as easy to just sort of jump into crypto as perhaps people imagine. What is the constraint?

Why is it that the money is just trying to get in? Yeah, it's a really good question. And the answer is a little bit different for different parts of money, but the high-level structure, if it looks somewhat, you know, similar, which is basically you're, let's say, a big bank, right? And all of your clients are asking you, can you please get into the digital asset space? We want to invest and we want a access token through you. And all of your traders are saying, hey, we want to be trading crypto, you know, as for the

prop desk for the firm. And, you know, random employees are. are coming up to you, the strategy person or whatever at this bank every day and think, hey, why aren't we doing the crypto thing yet? And so you go to compliance, basically, and you say, hey, we'd really like to do the crypto thing. Like, I know last time we asked, you sort of groaned, but like, could you give, you know, maybe give us a little bit more than a groan, right? Like, put some words that grown, and it sort of like grown really loudly.

And they say, can you tell me what regulatory framework? are we going to be under? You know, compliance comes back and says, well, okay, like you want to have this conversation. Sure, we'll have it. Talk to me about why you think we are allowed to do this, right? And, you know, at its heart, people are sort of like, oh, boy, like, you know, why are we allowed to do this? Well, people wish back and say, like, well, what regulation are we breaking?

And compliance is like, you know, understand, like, we are the first ones who are going to get sued if there's anyone who's going to get sued here by a regulator. We can't point to a regulation we're breaking here. We need to know what regulatory framework are we a part of what licenses are necessary to play different roles in this space, right? And if the answer is, as it is right now, basically like we're working on it. Right. Right?

Like as a country, like as global society, we're working on it. That's not a great answer. And that's like roughly where the money gets trapped. So when you say money, is that like, I mean, what you're describing sounds like the sort of regulatory environment that a bank lives in. I'm less convinced that's like what an asset manager lives in. Like, do you mean mostly banks or like sort of everyone in TradFi? Well, yeah, it's a good question. It certainly isn't everyone in TradFi.

And in particular, the closer that you get to something that looks like proprietary owned and controlled money, the more you are able to do something here. Right. And so when you look at, for instance, a prop trading firm that is trading, I mean, on one extreme, you know, take one that's trading entirely for its own book. So it doesn't even have customers, doesn't have LPs, doesn't have anything. Right. From their perspective, this is a lot clear, right? From their perspective, the answer is a lot closer to like, oh, well, you know, here's our deal. Like, we trade things. That's what we do. We're going to trade this other asset class. And the office itself is like, look, we're not showing this to customers or anything. We're going to. We're going to trade this to customers or anything. We're going to. We're going to trade. We're going to trade. We're going. We're going. We're. We're. We're going to trade this. We're. We're. We're not sort of in the line of fire here. So that is the area that we've seen sort of most come in early to this space. But if you sort of take a step back, actually even a lot of other money managers end up in the more concerned bucket, shall we say. Take a look at like a giant ETF company, right? Like that's an example of like an asset manager. A lot of assets are in are in ETFs and other sort of similar funds. How many ETFs currently have cryptocurrencies in them? Well, the answer is like two or something like that. And again, you're getting back to questions of, well,

what are these? Are these commodities? Are these securities? Under which statute, are we putting them into the fund? Do we need to register them? They're having active conversations with regulators about this. And there's obviously been a lot of back and forth about attempts to have a Bitcoin ETF, which have only sort of come together so far. There are now Bitcoin futures ETFs, which are something. But there, certainly this is not a solved problem. Even if you sort of like elide the specific, you know, registration requirements around a publicly listed ETF and you look at sort of like private mutual funds for high net worth individuals, most of those are sort of sitting there thinking like, are we going to get in trouble somehow for this?

Compliance is somewhat uncertain and nervous about it. And so I think there, you know, you're still in a pretty messy situation, all things consider. The thing you're describing sounds like incredibly bullish for like the prices of crypto assets because basically you're saying there's a tidal wave of trillions of dollars of institutional money that they all want to put 10% into crypto and they can't but they'll figure it out and then like crypto assets will explode like is that the right way to read it or is there like I mean like the counter narrative would be like you know the sort of prop traders and like retail speculators have gotten so far ahead of that trend that like prices already reflect that demand how do you think about it? I think those three sides are the right way

think about it. And I do think this is the thing that makes me the bullish about like crypto asset pricing is just the amount of money that isn't able to access it today or able to that that isn't accessing it today, you know, one way or another, but directly could be and very well might start doing so over the next few years. That is, I think, the most bullish trend going on in the space. And on the flip side, right, there's this question of, well, has that already been priced in? That can only be the narrative in some sense for like so many years in a row before at some point you have to start saying, well, isn't that why people were buying last year and holding, you know, anticipation of this.

I mean, in the end, it's messy. Like there's lots of reasons that people would be. And I don't think that there's a very clean tally of this. And I think I'm still not bullish because of it. But I definitely do think this has already been prepositioned for a decent amount. Now, there's a limit to how prepositioned it could be, right? Because if you think about it, the scale of what. could roll into crypto, if you think that a few trillion dollars of actual capital is what could happen,

that's the entire market cap of crypto right now. If a few trillion dollars rolled into crypto, I'm guessing it would 10x in price, roughly speaking, from where it is. And so if you think that the odds of that are at least 10%, that alone can sort of justify it. And it's sort of like an argument that it sort of probably hasn't been fully prepositioned for by the world, which I think I like roughly believe in expected value terms, also like in median terms, what are the odds crypto will go up or down versus like how much will go up or down? You know, I certainly don't think it's like anything close to an inclusive argument that like it's,

you know, very likely to go up. You say crypto, like, I mean, my impression of like giant institutional interest is like the idea of having some portion of your portfolio in Bitcoin is very attractive. My impression is that there's a sort of like sharp fall off where like, they're not sort of thinking about the difference between other blockchains and like how to, you know, yield farm and stuff like that. Like, is that your impression as well? Or do you think that a lot of this institutional money is like, you know, wants to actively

trade lots of different cryptocurrencies? Yeah. I don't think they've decided is a real answer, right? Like, I think the real answer is that like, you know, if you ask them, they would say something like, I don't know. If you ask them, like what you mean by crypto? Like, what crypto? I think their honest answer is like, I don't know, you know, the crypto thing, right?

like there's Bitcoin, like, yeah, are there more? They're like, yeah, totally there are more. And like, are you, you know, intending trade more? I, you know, I don't know, like we certainly want to consider that, you know, down the road. Like right now our focus is on finding a way to get Bitcoin access and maybe Ethereum access to our users. Like, you know, but like absolutely, you know, we'd consider, you know, we'd be potentially interested in offering more. I think that's the sort of like messy confused answer that you would hear in practice, which is just another example of like, you know, things are not very orderly right now in sort of like money looking at the space.

Just on this point, and Joe kind of touched on it in the intro, but I guess this is sort of an existential question, but it feels like the market is in the process of maturing. And it also seems like FTC's whole purpose is to improve liquidity in crypto trading. And some of that should happen naturally as more money comes in. But some of it is you making a con. effort to do so. But at the same time, it seems like a lot of the opportunity in crypto has historically been from illiquidity and frictions and fragmentation in the market. Is there a tension there? Like, does the attractiveness of the crypto world start to ebb away as the market actually matures? It depends on how it matures in theory. And this might not happen.

But certainly, I think you'd ask most of the traders in the market, what they'd think. What they would say would be something like, well, yeah, we do think that P&L in basis points, you know, portrayed will sort of like go down over time. But we also think volume will go up. And that certainly has been what we've seen so far. Where if you compare it today to 2017, 2018, you know, I was busy trying to make money arbitraging Bitcoin's here versus Japan. And those trades were good by many percent. But, you know, there's a billion dollars a day of volume going on in each side, which is a whole lot if you're making many percent on it.

But, you know, what do things look like today? Well, there is one or two hundred billion dollars a day of volume that are trading in crypto. And so I think volumes are probably up like 50x or so. Since then, spreads, on the other hand, are down. And they're down sort of a comparable, you know, ratio. And so I think that so far, like, the story of crypto has sort of been like spreads are coming in and at the same time volumes are going up such that actually the arbitrageers are making about as much as they always did, although it's maybe harder than it was before. And you can imagine in the future that like that continues, that things continue to get more efficient, but that as part of, you know, the asset class getting more institutionalized, like, you know, volume and liquidity goes up a fair. bit, which increases the sort of like scale of activity people can have. That being said,

and part of me does believe that, but not all of me. Because it is also the case that like, at least as of today, we are probably over indexed on, you know, volume relative to liquidity. And I think one way to look at that is just looking at ratio of daily trading volume to market cap. They're trading, you know, comparable amounts to how much U.S. stocks trade each day. but, you know, have the market cap of Amazon. But I would definitely guess on the margin that, like, we are going to see compression in that product. Today's show is brought to you by Vanguard.

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People who have it listened to last April was the first time we had Yuan Sim, and we talked a lot about that trade, whereas like really difficult sort of operationally to execute, but just these crazy spreads between the price of Bitcoin in the U.S. and Japan four or five years ago, and how you could just, you know, how simple that that sort of opportunity was once you found a way to make that trade. As you've described, volumes way up, spreads way down. where are, you know, you mentioned too that there's like a range of sophistication. So there are some entities that I just want to have Bitcoin exposure. I want to have Ethereum exposure. And then there's other tradfi that's clearly way more sophisticated like entities like jump trading are doing all kinds of wild stuff. And we had their head of crypto on the podcast last year, kind of Korea. But what, you know, like where are the current frictions as you see them or the arbitrageurs

entering this market or seeing like what kind of things, obviously it's going to be. way more sophisticated than just buy US, sell Japan. Like, where are the existing inefficiencies sort of broadly in crypto right now? Yeah. I mean, they're a little all over the place, although obviously way smaller. In particular, I think it's a lot less well. You buy on this exchange and so on that exchange. As you said, it's a lot less identifiable in some sense is what it is.

So what is it? If it's not that, you know, some of this is just traditionally HFT stuff. You know, there's $150 billion a day of volume that trade. it's trading on a bunch of different order books. And when you say how efficient is it, right? Like how much price might these order books be? Well, I don't know, take two Bitcoin or Bitcoin futures order books right now. They probably each have fees of a couple basis points and a spread of a basis point or

some fraction of basis point or something like that. And given sort of like the funding rates and the premiums of futures and things like that and the time and cost to do one of these arms, they can absolutely be a few bips, you know, out of line with each other. And so in theory, you can sort of do out the math. Let's say that, you know, you made one basis point on each side, which would be a lot and would be like, you know, an impressive amount to make on the serve volume on 50% of volume in crypto, taking the extreme of like you were the arbitragee, you're the HFT firm. Then, you know, how much is that a day? well, a BIP on, you know, $50 billion of volume is $5 million of profit a day, which is,

you know, what, a billion and a half a year? And so that gets some sense for, and again, obviously I'm sort of like cutting a lot of corners in that. Like I don't want to sort of imply that like, you know, that is the amount that could be made. But whatever, maybe that gives some sense for like what the available scale here is of arbitrage profit in the space. And it, and it, it is like substantial. And so that's part of what they're doing. You know, what other things are there? Well, farming is actually probably, I hesitate to say that it's been the biggest source of, I'm glad you brought in farming. But it might be like, I wouldn't be shocked if you added up all the sophisticated firms together and said like over the last couple years, have they made more from farming or trading. The answer might be fun. Can you give me an intuitive understanding of farming? I mean, like to me, farming is like you sell some structured puts.

and collect premium. But perhaps there's a more sophisticated understanding than that. Let me give you sort of like a really, a toy model of it, which I actually think has a surprising amount of legitimacy for what farming could mean. You know, where'd you start? You start with a company that builds a box. And in practice, this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's going to replace all the big banks in 38 days or whatever. maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box. So what this protocol is, it's called Protocol X, it's a box and you can take a token,

you can take it Ethereum, you can put it in the box, and you can take it out of the box. Like you put it into the box and you get like, you know, an IOU for having to put it in the box and then you can redeem that IOU back out for the token. So so far what we've described is the world's dumbest ETF or ADR or something like that. It doesn't do anything, but let you put things in it if you so chose. And then this protocol issues a token. We'll call it whatever, X token. And X token promises that anything cool that happens because of this box is going to ultimately

be usable by, you know, governance vote of holders of the X tokens. They can vote on what to do with any proceeds or other cool things that happen from this box. And of course, so far we haven't exactly given a compelling reason for why there ever would be any proceeds from this box. But I don't know, you know, maybe there will be. So that's sort of where you start. And then you say, all right, well, you got this box and got X token. And the box protocol declares or maybe votes via on chain governance or, you know, something like that, that what they're going to do is they are going to take half of all the X tokens that will,

off reminted, maybe two-thirds, though, two-thirds of all offer X tokens. And they're going to give them away for free to everyone who uses the box. So anyone who goes, takes some money, puts in the box each day, they're going to air drop, you know, 1% of the X tokens pro rata amongst everyone who's put money in the box. That's for now what X token does. It gets given away to the box people. And now what happens? Well, X token has some market cap, right? It's probably not zero. Let's say it's, you know, $20 million market cap and a bunch of Arbor Treasurer. From like first principles, it should be zero, but okay. Sure. Okay. I completely reasonable comment.

I mean, that's not quite true, but it's like when you describe it in this totally cynical way, it sounds like it should be zero. But go on. Describe it this way. You might think, for instance, that in like five minutes with an internet connection, you could create such a box and such a token. And that it should reflect like, You know, it should be worth like $180 or something market cap for like that, you know, that effort that you put into it. In the world that we're in, if you do this, everyone's going to be like, ooh, box token. Maybe it's cool. If you buy a box token, you know, that's going to appear on Twitter and I'll have a $20 million market cap.

And of course, one thing that you could do is you could like make the float very low and whatever. You know, maybe there haven't been $20 million that have flowed into it yet. Maybe that's sort of like is it's, you know, mark to market fully deadly. alluded valuation or something. But I acknowledge that it's not totally clear that this thing should have market cap. But empirically, I claim it would have market cap. I agree. It shouldn't have any market cap in theory, but in practice, they always do.

Okay. That's right. So, and obviously already we're sort of hiding some of the magic in that, right? Like some of the magic is in like how to get that market gap to start with, but, you know, whatever. We're going to move on from that for a second. So, you know, X tokens being given out each day. All these sophisticated firms are like, huh, that's interesting.

Like if the total amount of money in the box is $100 million, then it's going to yield $16 million this year in X tokens being given out for it. That's a 16% return. That's pretty good. We'll put a little bit more in. Right. And maybe that happens until there are $200 million in the box. So, you know, sophisticated traders and or people on crypto Twitter or other sort of similar parties go and put $200 million in the box. collectively, and they start getting these X tokens for it.

Right. And now all of a sudden, it's like, wow, people just decide to put $200 million in the box. This is a pretty cool box, right? Like, this, this is a valuable box, as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they're wrong about that? Like, you know, this is, I mean, boxes can be great. Look, I love boxes as much as the next guy. Right. And so, so, what happens now, all of a sudden people are kind of recalibrating. It's like, well, $20 million, that's it. Like that market cap for this box, and it's been like 48 hours and it already has

$200 million, including from like sophisticated players in it. But like, come on, that's too low, right? Like, and they look at these ratios, TVL total value locked in the box, you know, as a ratio to market cap of the box's token. And like 10x, that's insane. One X is the norm. And so then, you know, X token. and price goes way up. And now it's a $130 million market cap token because of the bullishness

of people's usage of the box. And now all of a sudden, of course, the smart money, it's like, oh, wow, like this thing's now yielding like 60% a year and X tokens. Of course I'll take my 60% yield, right? So they go, they pour another $300 million in the box. And you get a site, and then it goes to infinity. And then everyone makes money. I think of myself as like a fairly cynical person. And that was so much. more cynical how I would have described farming. Like, you're just like, well, I'm in the Ponzi business and it's pretty good. And did any of this require any sort of like economic cases?

Just like other people put money in the box. And so I'm going to do too. And then it's more valuable. So I'm going to put more money in. And at no point in the cycle did it seem to like describe any sort of like economic purpose. So on the one hand, I think that's a pretty reasonable response. But let me play around with this a little bit, right?

because that's one framing of this. And I think there's like a sort of depressing amount of validity. Can you, can you comment on like the sustainability of that? Yeah. Because like, you know, on the one hand, you're like, well, a trillion dollars of institutional money is going to come into Bitcoin. And the other hand, you're like, basically there are a lot of Ponzi's that have done

really well. Right. So let me, okay, cool. I'll say on the cynical route. Think about like cynically what could happen here. Well, okay. So you've got things, boxes kind of. dumb. But like, what's the end game, right? This box is worth zero, obviously. And like that,

you know, you can't like keep this market cap or something. Like, at the other hand, if everyone kind of now thinks that this box token is worth about a billion dollar market cap, that's what people are pricing it at and sort of has that market cap. Everyone's in a market to market. In fact, you can even finance this, right? You can put X token in a borrow lending protocol and borrowed dollars with it. If you think it's worth like less than two-thirds, of that. You could even just like put some in there, take the dollars out and never, never, you know, give the dollars back and just to get liquidated eventually. And it is sort of like real monetizable stuff in some senses. And, you know, at some point, like if the world

never decides that we were wrong about this in like a coordinated way, right? Like, you're kind of the guy calling bullshit and saying, no, this thing's actually worthless. But in what sense are you right? Sorry, can I just ask on this point? I mean, So are you saying that the value has to derive from everyone agreeing that it's worth something? And I know, like, on the one hand, that seems like a simple point about crypto. But on the other hand, throughout crypto's history, there have been these different arguments about how it actually gets value, you know, use cases for the underlying technology, for blockchain.

Everyone's going to start migrating stuff on blockchain. And then you're going to have a real economic use attached to these assets. And that's where the value is going to come from. But are you saying that it depends more on everyone just agreeing that these are worth something? So really what I'd say is that it could come in theory from either. You can sort of get a market cap either because of cash flow, right? And then like Warren Buffett's like, fuck this. Like I'm going to buy this.

If it's that too cheap of a price, because I'll just buy it and own it and get cash flow from it. And that's great. Or you could see something get market cap in the way that, I don't know, Dogecoin or Shibcoin have, right? where people are just kind of like, ha-ha, and then they buy it. And if you're like, that's dumb, it has no cash flow, I'm going to short sell it. You lose all your money. And I, you know, that those like, at least like over the last few years, those have both been ways that like assets have gotten market cap. And I sort of like think that this starts to hint at like at least some interesting angles on this because like it's not just cryptocurrencies.

that have had this dynamic, right? Like, how about like, you know, AMC or Hertz or GameStop or meme stocks in general have like a very similar pattern to this? And the sort of like concept of like maybe people will pay something for it, even though it doesn't seem traditionally valuable, is not a crypto specific concept, although it certainly has become like. Although, I mean, I'm seeing GameStop, though, it's like usually that's the percentage. And I'm not judging, but the perception is that it's sort of like a perversion of what the whole point of like the stock market is, as opposed to like this is going to be like the basis of like this is new. Yeah, I've written that sort of thing before. Like I would have I would have sort of drawn the causality the other way. Like I would I've said that like, you know, the rise of Bitcoin allowed for things like GameStop and AMC.

But I also think that like there's a difference between something like Bitcoin where people are like, well, this thing. is a story of value and enough people accept that, that it becomes a story of value. And the box that you're describing where, like, no one has an emotional attachment to the box in your description, and I think also empirically, like, what they have is an APY number, right? What they have is they're like, oh, this box is paying us a lot of money, so we're going to stay in it. Right? So there's, like, with Bitcoin, you know, you can sort of say there's a sustainable value because of like just sort of like a broad social acceptance.

but like I feel like with a lot of this like farming stuff like it is box X like no one knows the name from day to day. It's just like this is the box that is yielding the most today. So I'm going to put money in. And I'm sort of curious about the sustainability of that. Yeah. So certainly some of them are unsustainable. And some of them are, you know, many of them by number and exactly the way you'd think that

they work. Right. Like the way these end is that like eventually people decide that this is no longer today's cool box. This is yesterday's lane box. And they go down a lot in price. And then people sort of move on to box number two. And if everyone did a careful accounting of where they ended up, I don't know. You know, would they've made money? Would they not have? It's a little unclear. Like some people would have, some people wouldn't have. It's sort of messy. And that's like, certainly how some of these quickly end up. But it's not how all of them do. And in particular,

let's maybe revisit one of the earliest assumptions about this. Right. The point where I said this is a box that does nothing but be a box, right? And that was like, I was being a little facetious there, although I do think it's like an important way to understand part of what's going on. But it's not really the case that the biggest of these claim to be a box that is nothing but a box. They claim to be a bit more than that. And, you know, you can query how much you believe the story that their value at its heart is coming from them being more than just. a box, but people certainly perceive them to be more than that. And, you know, examples of this, right? I, well, let's say, you know, what are some of the most popular staking programs? They're like, you know, historically uniswap of a compound. These are various boxes that have an actual product tied to them that has like a narrative about why it might become the world's next big thing. You know, maybe it's going to be like the preeminent decks, you know, maybe it's going to be the preeminent borrow lending protocol on chain.

And this like, you know, weird box-staking thing starts out as just this sort of like side show. So the bigger story of we're going to change the world with the protocol that we just built. Now, sometimes that side show becomes the main show itself. Because sometimes, you know, in the end, what really happens is that like the box plus yield nature of it becomes more popular than the original use case of it. But it makes it at least seem a bit less dumb and a bit less circular and a bit more like, you know, there's something real that many of these are drawing on and a real hope that it's going to become itself a valuable protocol. So obviously, okay, maybe defied crypto will become very important.

But I'm still just sort of like curious, you know, just the sort of pure making money side of this. You estimated that sort of the arbitrage market for Bitcoin, maybe there's potential one and a half billion dollars and profits out there for the taking. Like, how big is the farming industry? When you talk about like this is a news besides trading, this is the other big way, how big is the putting money in a box industry getting? And I'm also curious, like, you know, one of the things that people in this space talk about is you can, thanks to FTX specifically, and thanks to the perpetual futures that it lists for so many coins, I could buy the coin, farm it, short the future

on FTX so that I don't even have to take a directional position on the coin itself and just sort of milk the farming yield. So can you just describe like how big is this sort of like ecosystem and how sophisticated are the trays getting beyond just sort of like the naive or simple like crude put money in the box trade? Well, let's do like some rough ballparking. There's something $200 billion of quote unquote TVL total value locked on chain. And now a lot of that, is basically irrelevantly loft on chain. And you can sort of ignore maybe $100 billion is sort of like the real number or something a little bit less than that.

Yields are certainly down a fair bit, but I think we're looking at like, you know, mid to high single digit percents on average or something like that. And so I don't know, you know, mid to high single digit billions of dollars a year of, of going quote profit that are being made by farmers actually doesn't sound insane to me as a ballpark of this, which that's a big number to the extent that this is real. profit, it's, you know, we might be talking $5 billion a year that sort of like traders are making from farming. So, yeah, the numbers here are not tiny. And they're plausibly bigger, probably bigger in aggregate than trading returns and group. I'm not. I don't want to like

100% swear by that comparison, but I think it might be right. It is not out of line with like my sort of instincts and prior and bits and pieces of knowledge I have here. So it's a lot. One I think one thing which is worth noting here, right, one parallel is, well, okay, let's say that you have a company, right, and this company delivers food, right? What it does is it goes to restaurants and picks up food and takes it to houses and puts the food there. And there's a few of these, right? What would be like how you would think this company would do during a pandemic? You would think spectacular, right? In fact, the pandemic was a very trying period for some people. food delivery companies because their unit economics were negative. Like they were running out of loss and had been for years. And the pandemic meant more business, which meant more loss for them. So paradoxically, it was negative. And how did that happen?

Well, what's the actual full flow of funds there if you take a step back? Well, the company, why are they running at a loss? Well, VCs keep funding them, right? People keep putting money into the company here. And the company then has stock price goes up because this metric, business, revenue, a metric that isn't actually profit, goes up. And, you know, as long as sort of like that keeps happening, right, people keep putting more and more money into the box. And the associated security in this case is because it is tied to the ultimate profit or something like that of this company goes up and up. and, you know, it keeps spending more money than it's making on things that are causing it to make that money in the first place, like negative unit economics or just shit tons of advertising or something like that.

And then it gets more and more business. And because it gets more business, people are like, that's great, losing even more money, bigger numbers. Let's put more money in. The goal here being, collect all the money in your box, see, you look a lot bigger than your competitors and they sort of give up and you win. And then in the end, you get all the real business. And basically it's just all an advertising budget, right, as much as anything else. This is all a way for like, you know, your box to get more notoriety and ultimately end up getting real business six years later because of that.

That seems like standard operating procedure, frankly, for startups right now. And it's very similar to what we're talking about in some ways with these epiphy protocol. They say abs are made in the kitchen. Cool, but who has time for three hours of meal prep and a fridge full of Tupperware? That's why I started using Factor. Factor delivers fresh, never frozen, ready-to-eat meal that are dietitian designed for balanced science-back nutrition. No prep, no cleanup.

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And there's one other aspect of it. that I've been thinking a lot about lately. And I'm trying to think how to phrase this, but it's pretty clear in crypto that you want to avoid dealing with Fiat currencies as much as possible. So onboarding is tough, or there are tax reasons to avoid doing that or whatever. So the way everyone gets around that is through stable coins. But stable coins are basically just trying to replicate the dollar for the most part, right? So you're not really getting away from Fiat. You're just replicating it in a way that fits into the crypto ecosystem. Is that a problem for crypto or at some point conceptually should stable coins go away?

I guess the question is like what is the point of crypto if everything is eventually underpinned by the dollar anyway? There is an interesting question of like what happens to the price of Bitcoin and other digital assets. in the face of stable coins, if they obviate the need to have an actual asset that is not tied to the dollar in the first place, right? If it's just like dollarization takes over, so to speak. Like I think that's sort of an interesting question. I think when you look at, well, is it bad to have a dollar like asset in the system? I think, no, I think it's super powerful. And I think what I'd say is like I'll try and send $100,000 to the guy saying next to me.

or it's the woman saying next to me. And you know, you'll try and send $100,000 the person's sitting next to you and we'll have a race. And I'm going to use USC and you're going to use USDC or USDA rather. And I have a guess as to who's going to win that race. I have a guess as to whose money is going to get there first. And if we want to do some, you know, a race to someone who's sitting in Nigeria, boy, do I have a strong guess about, you know, whose money is going to get there first and who's going to have spent more doing it. And so I think that to some extent, right, a way you can see this is. Wait, can you unpack that a little?

Like, when you get the USDC to the guy in Nigeria and then he wants to buy a sandwich with it, what happens? Right. So right now, there's a sense in which it doesn't accomplish all that much. If the next thing he has to do is figure out how to cash out USBC for a USD wire transfer anyway, right? And then, like, by the time he's bought the sandwich, you know, your crypto transfer did nothing because it all bottomed out in the same place anyway.

That being said, I think there's like two. reasons that I don't fully buy that response, one of which is, you know, eventually you could imagine a world where the sandwich guy accepts USC, right? And once a sandwich guy accepts it, then he actually never needs to go into, you know, into fiat directly, right? He can just stay in, in crypto land the whole time, and I think that it is in some ways actually just more efficient. So that's, that's one answer to your question. But another answer to your question is, is, you know, their services, FTCS is one of them, that can convert easily between dollars and fiat currencies and can act as, you know, point of sale I converters there so that people could

go to a, you know, sandwich store and like, pay with crypto, but the sandwich store receives, you know, local fiat currency. And there still does have to be a conversion involved. But now what we're saying is that, like, one, a few companies have to figure out how to do that conversion in large bulk size, you know, netting it all out somewhat efficiently, which is a lot easier than if you're trying to live in a world where, like, person had to figure out how to do this in order to send money to, like, their aunt back home. And you could still end up in a world where, like, for almost everyone, this system is extremely easy. And, like, there are a few points that deal with the converting back and forth, but, like, removes 80, 90% of, you know, difficult

parts that would have needed to happen. What's your take on the rise of either algorithmic or partially algorithmic, partially backed stable coins? One of the most interesting phenomena happening right now is the rise of Luna and UST. And Luna has this Treasury Reserve consisting of a lot of Bitcoin, which seems a little dicey. But some people say any idea of like an algorithmic back stable coin is a perpetual motion machine. It's only a matter of time before it fails. Like, do you believe there can be like a truly sort of like decentralized stable coin? Like, what do you make of these projects? I think they're really cool. I do have some sympathy to the perpetual motion machine crowd here. They can serve some useful purposes. But if you do zoom out, right? And you say this is a stable coin backed by volatile

assets. What's going to happen in a big market move? Right. Like, you know how this plays out. It certainly seems like it's only asking for trouble eventually, but a lot of people are excited about it. I think that's right now. Again, you could say, like, look, we want, like, this on-chain algorithmic coin for these reasons. And, like, the goal isn't for someone to sit there and hold it for five years. The goal is for it to use briefly for, like, transactions on-chain and get created and redeemed on-chain really frequently. And I think answers like that can make sense. I think there's also versions of, quote, unquote, algorithmic stable coins that do have risk in them, but that also have massively enhanced yield because they're taking that risk on in order to do a trade that makes.

makes money effectively, right? They're almost like money market funds in some sense, you know, that class of them. And that can make sense as well from sort of like an economic perspective. But I am skeptical of, you know, thinking that like a typical person is going to want to, for long periods of time, hold a typical algorithmic stable coin that isn't paying interest because it's just like, you know, someone said, hey, great, it's new things. Kind of like a bank and put your money on it. But every four years, it might go to zero. And that's the difference. It's not super compelling.

So we've covered straightforward HFT arbitrage type stuff. I've covered yield farming. If you asked how people are making money in equities, right? Like one of those things is true anyway. But then like a lot of it is options and structured products and like kind of packaging stuff in weird ways. Where are we in that part of the ecosystem in crypto? I know there's things where like people are doing like kind of defy structured products

where like you can like kind of put your money in a pot and sell options. How should I think about that as being part of the ecosystem? Yeah, it's a good question. And I think the answer here is actually a little bit weird and surprising, given everything else that's going on, which is, eh, not that much. It's not that surprising when you listen to the description of yield farming, but okay. Right. I agree.

I think about mechanically does clarify a little bit why options haven't taken off, but they really happen. Volume and options is very small. compared to volume in futures. When you look at most of these defy primitives that have taken off, most of them are way simpler than a typical options contract would be. By and large, I do think it's the case right now in crypto that like sort of more complex structured products just are not that big compared to the sort of like simplest pseudo-perpetual

motion machine you could envision. Because you read all these stories about like Goldman doing OTC options trades. I mean, is that like kind of... Oh, no volume. I mean, I... Yeah, I don't know for sure, but I strongly suspect that where that's coming from. You know, I don't think that that's coming from Goldman sitting there and saying, we're going to go like do OTC options in crypto because that's where all the money is.

Like everyone's just printing money, doing OTC options in crypto. Why are they doing OTC options in crypto? What's the actual reason that that's a thing they're doing in advertising? Can I guess? Yeah, go for it. My guess is that someone at Goldman was like, let's put money into a box that's a Ponzi scheme. And someone else at Goldman was like, we are absolutely not going to put money in a box that's a Ponzi scheme. And then someone at Goldman was like, what's our comparative advantage?

Well, we have is this with a bunch of hedge funds. We, you know, we can price an option. Let's try to like, you know, rub some sticks together and drum up an OTC options business because then we'll have, you know, we'll have customer. for that, whereas, like, the actual money-making place is a little too insane for our kind of regulated, somewhat risk-averse situation. So that's absolutely a lot of it. But at the end, you touched upon a key part of it, which is regulation, right? If you're a Goldman and you're trying to think, like, what crypto thing can I definitely

do? What will my compliance department just sort of stammer if they try to object to? Like, what do they just not have a case on? The answer is, well, CFTC listed cash-settled products where I never, ever, ever have to have the physical, where I never have to actually have on me any cryptocurrencies. And why is that important that you never have to have any cryptocurrencies on you? Well, it's because if you need to actually hold a cryptocurrency, you start thinking about things like Basel's capital requirements, right? And other sort of like fun notions like that. And it becomes a shit show really fast.

But if you do nothing but cash settled derivatives, you never have to touch physical. You don't have to figure out the security of it. You don't have to figure out the capital requirements. You don't have to figure out the regulation of doing that. And like CFTC structured products, which are cash settled. I mean, there's the exchange side that you can trade, but also there's a well-developed regulatory framework for OTC cash-settled derivatives contracts for institutional counterparties for institutional counterparties using ISTAs. That sort of like is another well-understood, really clean operational concept to do. And so it's lamp posting as much as anything else, right?

It's them saying like, what is the one thing regulatorily that we feel comfortable doing in this space? Let's go do that. On this topic of making money, the other obvious thing that's sort of like from the beginning of crypto, we talked about arbitrage and farming and all this is obviously there's still smaller tokens all the time flying. And so I'm just curious, like, what are the different approaches essentially that either institutional money or quasi sort of like VC money is taking to essentially like find the next big thing?

How do like people know? I mean, at this point, I think I want to sort of like zoom out a little bit and say, let's even put crypto aside for a second. How do VCs find the next anything that they're going to invest in? Right? Like how did they find the next company they're going to invest in? And I think my answer to that is like when you break it down mechanically to what's happening, you get a bizarre fucking process.

Like you get something that does not look like the paragon of efficient markets that you might expect. Where it's like what was mechanically happening? Well, they like see what all their friends. are chattering about, right? And their friends keep talking about this company or this token or something. And they start phomoing. And then their LPs are like, yo, have you made us a lot of money off of this company or token yet? And you're kind of like the answer is, no, we haven't invested in it. But you know that's not a good answer given what question your LPs just asked. So instead you're like, oh, boy, you're going to be excited about what we have done and or will do. And then you find a way

to get into that token and or company. And all the while, you're like, how do we justify, is this a investment, like all the models are made up, right? Like, things are currently being valued off of 2025, right? But it's not 2025 yet. It's sort of like an interesting property of trying to value things off of 2025 EBITA, right? You're valuing them off of a model built by a person who owns the thing that's being sold. So like, of course the numbers can go off between now in 2025, right? It's going to go up an arbitrary amount. And you can justify anything by just like, you know, that graph goes up and off. And eventually like, holy shit, LPs, boy, are you going to be excited about the stuff that we're buying on your behalf? It's like bizarre processes

like that, ultimately that are like shaping BC's investment decisions both in traditional equities and in crypto currencies. Well, there's tons of more to talk about, but we're going to have to pick it back up. Sam and Matt, thank you both so much for coming on Ava. Of course. That's always. It's fun. Yeah, that was great. Thanks. Thanks so much, guys. That was great. Yeah. Tracy, I love that the best, the highlight was definitely Sam's description of yield farming that even sort of crypto cynic.

As a magic box that you put money into and more money comes out. And even Matt Levine was like, I would have never described it this way because I thought it would be too cynical. Yeah. I don't really know what to say about that. That was a little bit surprising. But it does, I mean, it does clear up a lot of questions that I had about Defi. He sort of hinted at this idea of like the very.

value either coming from actual economics and use cases versus everyone just agreeing. And I think honestly, one thing we've seen, one thing we've learned over the past 10 years is that everyone just agreeing something is valuable. Sometimes it works. And like I wouldn't necessarily say that it's going to work for all the coins in existence. But the fact that it's been working for so long certainly has surprised many people, myself included. Yeah. No, that's the thing like it's like, oh, this is ridiculous. There's a perpetual motion machine. And yet here we are in 2022.

And the industry keeps going. Yeah, machines still going. Meanwhile, so the way DFI works is you put in a money in a box that you think more people will put money into the box. And the way VC works is you hear what your friends in the industry are investing in based on 2027 numbers. And then you also want to get on that. So it's really just FOMO all the way down. Well, so here's the other thing I would say. And Matt kind of touched on this too.

But the idea of momentum trading is not, you know, that is not entirely unknown in finance. In fact, it has been a very profitable strategy, arguably since 2008 in the financial crisis. So I don't know how to feel about it. I feel weird. We all feel weird. Well, I mean, one thing is clear, which is there is just a lot going on in the space. But in the meantime, shall we leave it there? Let's leave it there.

Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. Follow our guests, Sam Bankman-Fried. He's at SBF underscore FtX. And Matt Levine, he's at Matt underscore Levine. Follow our producer, Carmen Rodriguez, at Carmen Armin. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.

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