On The Brink with Castle Island - Tim Rice and Ben Celermajer (Coin Metrics) on a new measure of cryptoasset supply (EP.99)

Episode Date: July 6, 2020

Tim Rice, Coin Metrics CEO, and Ben Celermajer, index manager at Coin Metrics join the show to discuss a new supply measure for cryptoassets which takes into account their "free float." This is designed to take into account coins which are immobilized or illiquid, and brings a systematic approach to the issue inherited from traditional capital markets. In this episode:  Why Coin Metrics developed a "free float" measure of supply and why it's informative to investors How CM borrowed from index weighting strategies in equity markets to devise a free methodology for cryptoassets Why the highly auditable nature of cryptocurrencies allows for extremely informative assessments of supply The lack of standards in how supply is assessed among existing data providers Which assets saw the greatest reduction in supply due to the free float adjustment How market capitalization in equities in indexes went through a historical transition from total supply to float-adjusted supply For more on free float supply, see CM's introductory research piece on the topic. 

Hello and welcome back to On the Brink with Castle Island. I'm Nick Carter. So this week we have a very special episode with Tim Rice, the CEO of Coin Metrics and Ben Sellermeyer, who is the index manager. Many of you will be familiar with Coin Metrics, of course. What the team has done is they have developed a new version of supply for major crypto assets, which is mindful of the actual market-relevant float of these coins. So they've effectively, ported this concept over from traditional capital markets where equity capitalization is also, in many cases, assessed on a float adjusted banner. What does this actually mean? So instead of considering all of the units which exist on the ledger, you remove coins which are not market relevant,

you remove tranches of assets which aren't providing liquidity to the markets. And the idea is to develop a more authentic concept of supply, which is mindful of the fact that for cryptocurrencies, coins can be lost, they can be immobilized due to bugs. These things are bare style assets, and it's easy to lose them or have them be rendered not market relevant for some reason or other. Now, this isn't meant as a replacement for supply. It's a complement to allow investors to obtain a more precise estimate of the actual supply, which is market relevant. And as a disclosure, I am on the board of Coin Metrics, and it is a portfolio company of Castle Island. So without further ado, let's jump right in.

Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called the Bitcoin.

Bitcoin. Today with us we have Tim Rice, CEO of Coin Metrics and Ben Sellermeier index manager at Coin Metrics. And Coin Metrics has created a pretty awesome new product relating to a more accurate or for just fundamentally different approach to supply. So thanks to both of you. Welcome to the show. Thanks, Nick. Really excited to be on.

Thanks, Nick. Looking forward to it. I was thinking we could just, you could both tell us about your backgrounds and how you came to be a part of this, of this great organization. Tim, why don't we start with you? Thanks, Nick.

I've got 35 years of experience in traditional capital markets data provision. And I got into crypto from the blockchain side of things, 2016, trying to build a crypto-native data solution for traditional capital markets. And then after kind of building that a little bit and taking it back to customers, folks were kind of professional institutional investors, were looking for a data set that they could actually get into the market trust and invest in. And that's when I stumbled across.

COIMTric is an opportunity. Ran into you, Nick, actually, and thought the early base that you were building at Coin Metrics on the network data side of things would be a big compliment to what I thought was going to be important on the market data side of things. And then the further extension of that is our index business, which is something that we're super excited and we're kind of here to talk about today. Hi, and I'm Ben and I come actually from Sydney, Australia. so quite far away, but my background was historically in consulting where I worked at Deloitte

and that's where I first kind of got interested in blockchain technology very much from a what can it do for traditional finance perspective, but the finance function, not finance as a capital market, quickly realized that the solution probably wasn't going to do anything too quickly in traditional finance and pivoted to looking more at crypto assets and what they can do, how they work, and was fortunate enough to get introduced to Coin Metrics whilst I was over in Boston studying at MIT where I did an internship over the summer and have since joined full-time as index manager. Well, we're very glad to have you, Ben. Thank you. It's been great to see you know, you lose those, those blockchain shackles and become, you know, a hardcore crypto enthusiast.

I think a lot of people go through that same kind of intellectual training. Yeah, it was a fun ride and a fun realization when it happened. So I think a lot of people know about coin metrics. They read the newsletter, which is one of my favorite, if not my favorite newsletter, state of the network. and they will use the data on the site. You know, a lot of it is just open source and free data. But people tend to be less familiar with Coin Metrics's actual product lines and how they make money. So Tim, maybe you can tell us a little bit about that, about the commercial side of the business.

Yeah, great. We're kind of following our early ethos, which is to give back to the community as much as possible and kind of empower people to make informed crypto financial decisions. And so we do a lot of community data, as Nick said. At the core, what Coin Metrics does is we run 33 unique blockchain nodes. We connect up to 30 crypto exchanges, both spot market and derivative exchanges. And we ingest all of that content in order to create our metrics on the network data side of things.

We do a lot of work on the market data side of things as it relates to just. generating what's the value in US dollars for things. But we've taken that a step further where one of the problems we saw was looking at a reference rate. What's an aggregated view of the US dollar Bitcoin market? And how do you examine the constituent markets that should go into what we would believe is a valid US dollar Bitcoin price? So we ingest all of this market data content to do that work. And then on top of that, we kind of fundamentally believe that indexed,

are an important way, whether through an ETF or an ETP or some other vehicle, to either help the traditional investor get exposure to crypto or to use that as a benchmark. And as we were going through the process of figuring out how you would enable an index per se, we identified a number of critical points along the way that would be important. So we've kind of solved the network data side of things with what we do at coin metrics. We've solved the market data side of things with our ingestion and algorithms we run to calculate price. And we bring that all together into our index business. What are the key things that make an index investable or usable as a benchmark? And that's where we kind of got into the hard study around the topic that Ben wants to discuss free flow today. But basically, we offer our paying clients a professional set of metrics from the network data side of things that's more extensive than what we show on the community.

community side. And on the market data side, we do everything from connectivity to exchanges for, you know, streaming web sockets to collecting on detailed order book at the tick level, to creating our reference rates, which then we work into indexes as well. So our points of monetization along the way are always kind of looking up market, giving away some kind of free aggregate value that helps inform the investors. And then as you drive down deeper, the things that we spend a lot of money on our storage people and intelligence to kind of create those things. And so, you know, we give away as much as possible. And, you know, we've found a good niche for ourselves as far as supporting institutional

investors. Yeah. And so the interesting thing about index construction in terms of a basket of assets is, you know, how to weight those assets together. And it's kind of been very primitive historically in the industry. I'd say. Previously, the big sticking point has been supply, you know, that's kind of a necessary component of market capitalization. And for the most part, these indexes tend to be cap-weighted indexes, as is, you know, which is also typically the case in traditional capital markets.

So I guess this was kind of a necessary step along the way if coin metrics was trying to get into the index construction business. Yeah, I think that's very much where we settled on coming up with this free float metric was that when we kind of surveyed the landscape and tried to understand how we were going to weight a multi-asset index, we kind of looked at traditional approaches, we looked at what was available in the market and just saw a lack of conformity on any single service. set of supply metrics that we could observe and as such decided to kind of take some leads from what happened in the traditional market and the journey that they went through to get to where they

are today in terms of understanding what supply is available to the market and kind of apply that to crypto assets for our own set of indexes. And I guess coin metrics is kind of uniquely well position to do this because we have this understanding and this ability to audit the ledger in a really precise and comprehensive way. So because these are bare assets, they can be lost. Or the nature and distribution of the assets is also very transparent and very auditable. So you really do need to combine that kind of market data function with this assessment of the actual truth as the ledger is representing, right? Yeah, and I think that's where I as an index manager, I'm extremely lucky to have the support of the market data function team that we have and the network data function team that we have at Coin Metrics that did allow me to kind of execute on this methodology.

I guess, as you say, the kind of plethora of information that Coin Metrics aggregates, gathers, the nodes we run, the market data we have, it does a lot. allow you to build this very comprehensive picture and come up with the metric that we can back and we can ultimately go to market with. So, Ben, you mentioned that you did a survey of the kind of state of affairs as it relates to supply for major crypto assets. What did you notice from that kind of investigation? Yeah, I think that, I mean, the most obvious observation, is that there's no conformity across the market. Most of the data distributors have their own way of reporting supply, and they vary in numerous different ways.

Some of them, some will look at what the foundations and founding teams report as being supply. Some will look at what's on visibly on the ledger or what you can see on the ledger, and some of them will do this kind of forensic analysis on an individual case basis to understand the dynamics of that specific crypto asset. And I guess one of the things that you do notice is that even if one data provider does take some of those approaches, they'll often take different approaches for each different

assets. So there's no consistency in how supplies observed or applied across the market. And which of the kind of large gaps had, the most variance in terms of the supply that was being reported? I think that it's a tough question. I mean, why it's a tough question is that the way that we've applied our supply methodology, there are huge differences between, for example, the way Bitcoin SV supplies being reported versus the way that we report it.

And the reason for that being that if you just look at what's on the ledger, it's got a very similar supply to Bitcoin, which is that 18.4 million. Whereas if you look at only coins that have been activated since the fork, but by activated, what we mean is that a UTXO has had activity. And if we just look at that component of it, only about 10 million have been active since the time of the fork. And we feel that that's a much better measure of what's potentially in the market and available to the market for transacting. Therefore, we feel that that's a much better representation of supply, which does represent a 45% reduction in the free float figures that we report than what's traditionally used. Yeah, some of the other big ones were ones like Stella or Maker where we've identified alternative wallets that fall into categories of holders that we deem to be long-term or strategic holders that don't.

provide liquidity to the market so they can they can result in varying varying reductions in the supply that will report under free flow and what was the intuition or the theoretical basis for trying to find an alternative measure of supply which is restricted to only the market relevant units yeah so the the motive again was when we're constructing indexes the one of the first things that we look at is how investable would the index be long-term And when trying to create an index, you need to understand, you need to try and reflect the, you need to try and reflect the market as best you can.

And in doing so, you need to be able to reflect the liquidity profile of the market. And what happens very quickly is hopefully some of these indexes grow and become investable or become invested in the hundreds of millions of dollars down the track, you need to be able to accurately represent supply so that you don't run into liquidity issues and have index managers or asset managers having these huge administrative costs and index turnover fees and tracking error that can be avoided by having a better understanding of the liquidity of the market. So for example, if you're trying to wait one of your indexes with the 18.3

4 million Bitcoin SV number and you're a huge, huge, huge ETF or asset manager, you might not find the liquidity you need in the market, given what weight the index gives it. So this actually mirrors a problem and this was a transition that happened in traditional capital markets, as you were telling me before. So can you talk us through kind of that transition and what happened in terms of index construction for equities? Yes. So funnily enough, when we were investigating this, traditional capital markets went through a very, very similar experience. And prior to the 1990s, traditional capital markets largely weighted their indexes on what we in crypto would consider the on ledger supply or what's visible on the ledger. So just the total amount of shares that were outstanding within that company.

But then in the 1990s, there's a lot of tech companies started to pop up. They started only issuing less than 25% of shares and only making a portion of what's outstanding available to the market. Again, the asset managers had a very, very difficult time weighting their indexes when you had these huge market-cap-weighted companies, and they had to buy, the index funds collectively had to buy a percentage of the percentage of the market that they were being told when they found that most of that supply wasn't available on the market. It was held by the company or held by private equity companies that were investing contracts.

So they had a lot of trouble seeking liquidity and being able to balance their indexes. So what they did was, I think it was Futsi did it first, but they did. They came up with this concept of looking at categories of investors that didn't supply liquidity to the market. And they came up with their own free float methodology that kind of looked at what was on the market and started weighting indexes that way. For the purpose of indexes, they realized that it was a bit opaque in terms of what you could see and what was the information that was available and being reported by these companies,

very similar to what we're seeing in crypto at the minute. And so when they constructed their indexes, they kind of put them in their own bands where they said, okay, if we calculate your percentage of supply available to the market to be 30%, we'll put you in the 30% to 40% band and you'll get weighted at a 40%. And that overcame a lot of the discrepancies

in reporting and also evened out the playing field a lot in terms of the companies that were super transparent and the companies that were rather opaque in their supply reporting. So we're kind of taking a similar approach and applying those principles to markets. Since reporting has gotten significantly better in traditional capital markets and they've been able to basically weight indexes on very accurate free float figures that don't use banding anymore. So it makes a lot of sense that the same methodology would be applied to crypto because you have assets, including some of the large caps, which have extremely low float relative to their total supply or the supply that could exist on the market. You know, stellar, I think, is one particularly notorious example where there's a huge difference in the market significance of the asset, depending on whether you count the sort of foundation-held token. or the tokens that trade on the market.

What were kind of the restricted categories that you inherited from the capital markets approach? And what were the new ones that you had to devise for crypto? Yes. Some of the ones that we were able to inherit from markets were traditional capital markets were ones like the team-owned tokens and the foundation-owned tokens.

Those are deemed to not be providing liquidity to the market. And if you historically look at some of these wallets, for example, as you say, Stella, where the foundation does own up to 80%, or they did own up to 80% before they burned 50 billion tokens, but they still own about 30% of what's available to the market. Sorry, 60% of what's available to the market. it's identifying that supply, it's identifying team-owned tokens. So teams can contribute to a large amount of supply that's available to the market. And a lot of the team-owned tokens are under vesting schedules. Or if you look at how they've behaved historically, typically the team members are hoddlers of the token.

So they don't transact as frequently or provide liquidity to the market as frequently as as other token holder categories. Other ones that we were able to look at were any vesting tokens. So, for example, XRP have vesting contracts that we can view on chain and we can exclude those from the supply. And I think they're the main ones

that we were able to identify from traditional capital markets. Some of the ones that we couldn't kind of translate into crypto were government entity shares to our knowledge. No government's yet own much Bitcoin. And ones like VC's VC and P firm to own tokens. They're excluded from traditional capital markets. But in crypto, I think there's at least enough anecdotal evidence to say that a lot of

those providers do, a lot of those VCs do give liquidity to the markets in the short to medium term and therefore we've chosen not to exclude those. One of the other ones we've actually looked at, which is super relevant for coins like Bitcoin, which are old. In traditional capital markets, they look at the investors who own over 5% of supply as not providing liquidity to markets. And the reason they do that is because those investors are disclosed to markets and they're seen as having strategic interests in not dumping their share. on markets because there'll there'll be market impacting moves and they're seen as long-term holders. We haven't done that for crypto because a lot of those 5% holders will be exchanges,

which by definition do provide most of the liquidity to markets. But how we've translated that is we've looked at, we've categorized strategic investors as ones who've held the tokens on native units for over five years without transacting. And the reason we've done that is we feel that a five-year period is enough where they've gone through a ball market, they've gone through a bear market, and they've demonstrated that they truly are in it for the long term and they have no interest in moving those assets. Of course, some of the old Bitcoin that fall into that category will be lost and lost forever, but that's also a neat way to exclude those tokens

is not contributing supply to markets. So the new categories that we've looked at are the burn tokens. So burn tokens you can observe either they're burnt off the chain, in which case we don't need to account for them, or like in Stella's case where they've sent them to an unspendable address, we can exclude those. The other one that we've looked at, which is not comparable to traditional markets, is governance contracts that don't provide a financial incentive.

So that's particularly pertinent in the case of Maker, for example, where they've got a governance contract, where there's no direct staking benefit, but owners of the MKR token have to actively send their tokens there in order for them to benefit from part taking in the governance process. And we see those as very much long-term strategic holders of MKR or having an interest in the Maker Foundation and the Maker Project and thus exclude those from markets. And if you historically look back at the performance of that wallet, it has wavered significantly through peaks and troughs in the MKR, in the value of the MKR token,

which kind of helped us come to that decision. So I guess what you're trying to target here really is coins which are unlikely to actually make it onto the public markets anytime soon, which is not to say that, you know, you're trying to delegitimize these tranches of coins or anything. You know, they're perfectly legitimate. It's just they're not as market relevant. And what you're trying to do effectively is proxy the, you know, market weighted size of these coins, which is why you'd want to make these restrictions. That's exactly it.

That's exactly what we're trying to get to. We're not trying to say that these tokens are unspendable or they can't be dumped on the market. It's just looking back historically, it's what has, how is the, how have these. categories of token holders behaved and how they acted with markets. And if you do think of asset managers that might track an index, who are they buying from? Where are they getting the liquidity from? And that helps inform you as to how you should wait an asset in an index. So what were kind of some of the most startling findings? What were the biggest deltas here between the, you know, the naive market cap and then the flow to Justin market cap for some of these

coins that you found? Bitcoin SB, for example, is we report about 45% less than what's reported across all data providers. Bitcoin cash is about 35% less than what's reported. XRP is about, we report about 33% less. Most of the data distributors report around 45 billion. Supply, we report closer to 30 billion. Stellar, we report 16, 17 billion tokens.

Most of the data providers are kind of in the 20 billion range. There's some of the big ones that come to mind. So this actually does move the needle when it comes to a cap-weighted index. It sort of looks materially different. Yeah, yeah. It looks materially different. I think one of the big things with any cap weighted index at the minute is that if Bitcoin is included, which it is in all large cap weighted indexes, it dominates the index controlling about 70 to 75% of it, given the size of it in the market. But it does change what the rest of the constituents look like within the index.

For example, I think it increases the weight of Ethereum. It decreases the weight of some of those assets I mentioned before, like XRP, Bitcoin Cash, Bitcoin SV. And it does provide more weight to some of the smaller ones as well, where there are supplies a lot more on the market. And there aren't as many restricted tokens. And in terms of scaling this up to, you know, really all of the, you know, even beyond just the large cap tokens and maintaining these free float measures for potentially hundreds or even thousands of crypto assets in the future, how do you expect that to proceed? It doesn't need to become more scalable. Do you need, you know, foundations to become more active in reporting? Or how do you figure that's going to work exactly?

Yes, I think initially it will continue in a very similar manner to how we've conducted ourselves so far, and that's kind of going down the list of assets and knocking them off one by one. I think that to some degree, that that does become a long and arduous and manual task. And I think that as we move forward and as crypto assets become more legitimized in markets and accepted by traditional markets and regulators that there will be stricter requirements on reporting. And I think that that's where we'll see, that's where we'll hopefully see a lot more transparency and visibility from these market players in terms of reporting, in terms of timely,

accurate reporting. I think that's the, the other big one is timeliness of reporting. We haven't talked about, but a lot of the, a lot of these foundations, they'll only report, say, once a quarter, once every six months, once a year what their supply is, and therefore very quickly you get stale figures. Whereas in reality, as you know, Nick, because all this stuff is visible on a ledger and blocks on Ethereum are produced every 15 seconds and Bitcoin every 10 minutes, you should be able to update this in real time. So I think hopefully we will get to a stage where that's the case and and it's not as manual a task for us to for us to do this but once we

once we have it up and running we've got a we've got a system that runs in the background that tracks all the tagged addresses and all the all the wallet movements and where they're going from who they're going to and we can very quickly once we've identified an asset and released an asset we can vary a relatively with relatively low manual intervention maintain coverage for that asset. It's just the onboarding of the asset that might take a bit of time. So, Tim, returning to you, it's clear we have something pretty compelling here, pretty differentiated, which hopefully can change the trajectory of index construction at a very minimum and can potentially encourage issuers to be more transparent as data providers start to care more about these figures. How do you

expect the free float supply to be kind of commercially relevant? How would you be looking to deploy this kind of line of data? I think, Nick, you know, it kind of, again, goes to what we do with coin metrics, which is we're trying to kind of raise all boats in crypto. And so, you know, at the highest level, you know, the free float supply metric will be something we put out to the community version. We make available across any platform that would. you know, be interested in looking at it and we're happy to work with everyone and have a conversation about very transparent methodologies on how we did it, how we classified things, you know, where we get a little more restrictive on stuff is at the underlying level,

you know, as Ben highlighted, you know, we've got tokens that are enacted for five years. That's a dynamic term, right? Where basically we're monitoring a set of addresses that we've put into that bucket of those addresses and we'll constantly monitor those from movement or changes. so in any given time that could change. That level of data underneath all of this is something that requires our maintenance and ongoing effort, and we can make that available to people as they would see fit. But we believe at the aggregate level that the free float numbers need to be maintained

at the base level and then shared at the aggregate level. So our idea is to allow the industry to kind of use these free float metrics as far as creating so we have kind of that same continuity of supply across the various providers and across the various indexes so that investors can be confident that they're looking at the same amount of weighting or the same amount of native units being included in various index and do you have a plan for making this a standard alongside the current supply or kind of the ledger or evidence supply metric or do you expect it to just happen organically over time? Our goal is to release this and then go have conversations with everybody in the ecosystem.

And we do believe it should be a standard in the way we're going about providing that standard to the market is, you know, we will maintain it. We will support the on-chain components of it and we will enable the industry to use it in their metrics. We do think it's a standard. We think, you know, a lot of things that we work on, again, down to that transparency level, We lay out how we did it. We lay out how we build it.

We lay out how we're going to maintain it. And that's available for everyone to see. And, you know, we think that it's an important thing. And we're going to, you know, we're going to go out and have conversations. So it'll probably be hopefully a proactive on the coin metric side to work with people to get them to understand what we're doing. And then clearly we'll have to have a little bit of organic adoption and help support it. Yeah, echoing Tim, I think that we hope to, we do really hope to make this as transparent as possible so that, So that anyone can kind of, if they wish to, audit the work that we do and understand our methodology to the fullest.

And as such, all that documentation will be online. But where the market doesn't yet have a standard, as I talked to before, I think that there's hopefully opportunity to come up with a harmonious view of crypto asset supply across the market so that it's not as confusing to new people who are onboarding going to the various data providers and going but way. I thought supply was this and now I'm being told this and oh there's a third number and hopefully that having this one methodology that is a standard will lower the barrier to entry and help educate people in a lot cleaner way. So Ben, the free flow methodology has been released for a few days now. Have you received any pushback against any of the restrictions or the methods employed? or have people been generally pretty happy with it so far?

Thus far it seems that people are generally happy with it. We did a bit of, we had a few conversations prior to releasing it, many, many conversations internally, a few with external experts that I guess helped us form our opinions and kind of get to the view where we're at now. So hoping that it's very understandable. And I'm sure there will be pushback from certain parties or certain individuals, but you're always going to get that, aren't you? For sure. The one thing that I think you might get some pushback on would be restricting the five-year dormant tranche of coins, because that gives you a different supply figure from the generic Bitcoin supply of 18.4 million.

But you know, you're not necessarily presuming these coins are lost. You're just observing that they're effectively inactive and don't appear to be market relevant. Yeah. And I think to your point, we're not disputing that there aren't 18.4 million Bitcoin. There are very much 18.4 million Bitcoin. Anyone can see that from querying a node. A funny story was when we initially kind of announced that we were doing something like this and we released our Bitcoin number early on because that was one of the first assets that we covered.

Someone on Twitter popped up and said, but my one Bitcoin's not lost and I haven't moved it in seven years and it's still there and I can do whatever I want with it. He kind of got very defensive. But in having a slightly calmer conversation, I think we both came to the agreement that he wasn't providing liquidity to markets. and he had no intentions to do so anytime soon. So hopefully he thought it was fair that his one Bitcoin wasn't included. All right, gentlemen, well, this is really exciting. I really hope, you know, that the free float metric catches on. I think you've done a lot of really important work here to, you know,

insert some consistency into these markets and ask a little bit more of some of these token issues, issuers in terms of transparency. And I'm sure there's going to be a lot of derivative metrics that come off of this in terms of what insiders are doing and how they're liquidating their coins, which has been really opaque historically. In terms of actually following Coin Metrics's progress on this and staying up today, what would you guys recommend? I'd recommend you can follow us on Twitter on a Coin Metric handle, or you can check out State of the Network newsletter, which we published this in yesterday or visit us at coinmetrics.io. Adding to that, I think all of the metrics will be available on our community network data tool as well

for anyone to look at, observe, play around with. So that's somewhere else you can see the progress there. All right. Thanks so much for coming on the show, guys. Thanks a lot, Nick. Cheers. Thanks, Nick. Thank you.