On The Brink with Castle Island - Weekly News Roundup 08/28/20 (Fidelity's Bitcoin fund, is whisky a SoV, do security tokens make sense?) (EP.118)

Episode Date: August 28, 2020

Nic and Matt cover news and deals of the week. In this episode:  FTX acquires Blockfolio for $150m DCG announces a $100m investment in Foundry, a mining subsidiary Fidelity files with the SEC for a Bitcoin fund – and what this means for other asset managers Why large asset managers have not built products around Bitcoin just yet The INX situation explained Why security tokens might actually make sense The Boston Fed is evaluating 30 different blockchains for their digital dollar project Do exchanges owe depositors their forked coins? How will NYDFS react to the Wyoming SPDI? The Fed signals a more inflationary environment Can you use whisky as a SoV?

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 Concentive 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 a Bitcoin. Bitcoin. Welcome to On the Brink. I'm Matt Walsh. And I'm Nick Carter. And we had a busy week. We had a lot of people reaching out to me this week and hearing about my we work woes and the fact that there's no beer here. Some people said that they would give me beer.

It wasn't about the beer. I just, it's about the ambiance. I thought it was about the beer. No, it wasn't about the beer. It was just about like, you know, how, how, how, the mighty have fallen. Is there cold brew? Is there cold brew?

That's the important question. So there is cold brew, but not every single morning. Sometimes it runs out. So I think they're running on like a skeleton crew over here. That's devastating. Real metaphor for the state of the economy. We had a couple good podcasts this week. We had Dick Bavet, who's just a legend.

I really have been reading Dick Bavet stuff for a very long time. He's been an equity research analyst for 52 years, mostly covering the banking sector. So he came on the podcast, and we talked about just the overall health of the banking sector, the future of the dollar. He really sees China as not surprisingly the biggest threat to dollar dominance internationally. So we talked about that for a while and talked about the role of cryptocurrency. So he was telling people to pay attention to Bitcoin back in 2013 when it was $50. So I wish I listened to him that. I will say it was a very high quality week for podcasts, very high quality. We also had Zach Kelman.

Zach, you know, he was on the dark side. He worked for banks doing AML stuff. And then he realized, you know, he's got to fight back. Got to join crypto. And that was one of my favorite episodes I've done in a while because a lot of it was about the crumbling international order and how financial crimes enforcement fits into that. So he has some really interesting predictions about Europe becoming a haven for crypto companies. He thinks that Western Europe is really going to be poised to do well through this. That was interesting. If the world becomes, yeah, yeah, if the kind of U.S.-led order declines in importance,

he thinks Europe will be a mediator between the U.S. and China. So I guess we'll see. We will see. And then you had a couple articles this week. So you had one on CoinDesk talking about Ethereum's fees. Vitalik hopped in your mentions on that one. Yeah, Vitalik really took issue with what I wrote. So I guess I'm going to have to defer to Vitalik on the topic of Ethereum.

But my point was pretty simple. Like if blockchains are capped in block space, which they should be, then the highest value or the most economically dense transactions force out everything else, which we already know is the case with Bitcoin. Now we've seen it happen with Ethereum. And so my point was basically very simple. It was public blockchains are mostly financial infrastructure for the most part. And that's primarily their nature.

In Vitalik's basically disagreed. And he was like, no, we're going to be able to create lots of cheap block space, especially with ETH2. But, you know, ETH2 doesn't really exist yet. So it's hard to kind of evaluate it. Yeah, I think we're still in this age in the industry where there is this big question around. And you can find two schools of thought on this around whether or not base layer blockchains need to be money in order to be really useful. I guess I would argue that they do. Do you think that that's still up for debate?

I don't know. I feel like a lot of the big blocker arguments have been empirically rebutted at this point. You know, they were saying you could have unbounded block space. I think it's very clear that block space needs to be bounded. A lot of people that suggested that you didn't need fees for a blockchain, I think they're wrong. I think it's clear that fees are an important anti-span mechanism. Some of these feeless chains are just clogged with span. It's impossible to run a node.

Nobody even tries to run notes for these things, so they don't know. Yeah, it's a wasteland. And then you also had an article on Medium where you talked about kind of the future of Bitcoin and whether or not this, I think it's reasonable FUD, but the fear, uncertainty and doubt around the fee market emerging and whether or not the 21 million hard cap will go on. And basically the argument, I guess, on the skeptic side would be that the security of the network will be compromised when the block reward subsidy goes away and that we'll need to come up with a solution for that.

Some people are thinking that we would have to make Bitcoin inflationary. And what you're saying with this article is that, you know, if that happens, whatever that network becomes, that's not Bitcoin. Yeah, that's correct. I think it's valid to question the fees that might accrue to Bitcoin in the long term. But what I disagree with is that, the claim that Bitcoin will force to be inflationary because, as you say, like, if Bitcoin adds inflation beyond the predetermined supply schedule, I don't consider that to be Bitcoin.

That's something new. So Bitcoin will live and die on its own merits, but what it's not going to do is change. It's a most essential trait. Now, there may be other networks that emerge and most likely will be air dropped to the Bitcoin UTXOs. So I don't see there being any significant risks. I think having Bitcoin entitles you to whatever the successor is if there is one. But I do think it's important to be clear about what Bitcoin's core values are. And one of them is clearly the 21 million cap. I don't think it's negotiable. So just wanted to make that clear. I wasn't really saying

anything new, but felt like writing it anyway. I guess it's one of those things that people are starting to talk about, but really doesn't become an issue for another 20, 30 years. Yeah, it's hard to know. But yeah, if you look at the ProVorog blockchains that get attacked, they have very small security spend, and they have totally commoditized hardware, which is used to mine them, which is not the case with Bitcoin. So you want to talk about some deals? There are a lot of deals this week. Tons of deals, tons of defy deals.

One of the, I guess this is a big one. So Blockfolio, which is a crypto asset app. So it allows you to just check the price of cryptocurrencies. They've been acquired by FTX, which is an exchange for a reported $150 million. So big price tag here. It looks like it was paid in a mix of cash equity and FTX's native token FTT, which, you know, kind of reminds me of the coin market cap acquisition. They're required by Binance with probably a mix.

of cash and B&B tokens at the time as well. So totally. This is a marquee deal. I think the discourse was that it was probably a good move for FtX because they are, you know, fairly retail focused. Blackfolio's got tons and tons of users. And they make those kind of gamified financial products, which retail investors really like. So potentially very mutualistic.

Yeah. if you want to buy a bunch of users, then, you know, that's certainly an app like Blockfolio is where they are. So, congrats to the Blockfolio team. The next one is really interesting. So Consensus, which is, of course, the Ethereum Studio started by Joe Lubin. They have acquired JP Morgan's Blockchain Project Quorum, which was kind of their open source blockchain initiative that originally I think it was Amber Balday was in charge of that group before she left to do her own startup. And so it looks like JPMorgan is also making an investment in consensus as part of this transaction. So I don't really know what to make of this one. Yeah, I mean, my question is like,

how do you acquire an open source project? I mean, the code is all open source, right, unless there's some close source element to it. So I don't quite understand what this entails. Yeah, I don't. I'm not exactly sure, but yeah, good for consensus. this looks like now they have J.P. Morgan on the cap table as well. So we'll see. JP Morgan traditionally has not really been at the bleeding edge of public blockchain. So any move in that direction can't be a bad thing. So the next one is Bella Protocol, which is a defy company. There is $4 million from Arrington XP Capital with consensus, alphabet and coin Benet participating.

actually tons of defy deals. You also had perpetual protocol, a derivatives platform. They raised $1.8 million from multi-coin three arrows. CMS holdings in Alameda. Those are some funds that we see in all these deals these days. And then the next one is Frontier, which is a decentralized finance liquidity aggregator.

They raised $1.85 million from FTX, also Alameda, NGC, and CoinG. get-go. And then here's a deal that I think is pretty fascinating. So Ribbit Capital, which, you know, folks will know them as a just a powerhouse fintech focused venture fund and really on the bleeding edge of the crypto asset industry. They've been investing in infrastructure companies for a long time. They're investors in Zappo. They filed for a $350 million SPAC. And to me, this one is the one where you say, if any SPAC kind of operator, so far, far knows this space. It's definitely ribbit capital. So I would be really interested if they're

going to look at crypto asset infrastructure companies as part of this spec. So they're creating a spec or are they themselves going public through a spec? No, no. They created a spec. So they're the sponsor for a $350 million spec. So they're taking this holding company public and then they're going to go find a company over the next two years. And maybe they'll find a crypto company. So I kind of thought that we might get some SPAC news from DCG when Barry was teasing an announcement this morning. But actually what he was referring to was the official unveiling of foundry, which is their mining and staking business. And it's their fourth subsidiary.

And they claim to be dedicating $100 million to it. to effectively mine Bitcoin and other cryptocurrencies in North America. Yeah, and it also says providing capital and advisory services as well. So maybe they're also partnering with other mining groups. I'm not sure. But Barry had a tweet today that says that he thinks that they might already be the largest North American miner, which is fascinating. So, you know, this is what, the fourth subsidiary for DCG?

the others are doing pretty well got to say yeah i mean everything's doing well that thing is the whole thing is on fire over there it's like in a good way yeah so i guess foundry hadn't been publicly announced it was definitely something which people knew about a little bit before but officially out speaking of official announcements uh or maybe this one's a little premature but the big news they got reported in the mainstream press was that fidelity had filed for a Bitcoin fund, although it was a filing was not a huge amount of detail. And Fidelity, I think, didn't comment on it at all. So more details forthcoming in the future.

But this caused a fair amount of buzz for sure. Yeah. So Fidelity has filed with the SEC for what looks like a Bitcoin index fund. And the company has declined to talk specifically about what the initiative is. And so we're not going to kind of go down a speculation route here. But I think suffice it to say that if you are a large asset manager, you know, you should be paying attention to this. And rest assured that fidelity is like five steps ahead of you on whatever you're thinking. So, you know, it's really fascinating to me that we aren't seeing more traditional asset managers move into this space and offer these types of access vehicles.

If you think about the types of institutions that are seeking exposure to crypto assets and specifically Bitcoin, I guess to start. You know, you're talking about some serious endowments. So there's already been endowments that have publicly taken positions in Bitcoin and that have invested in infrastructure companies. Block 5, for instance, had two endowments in their Series C. So if you're a large kind of by-side institution that is working with endowments and foundations, these folks are already trying to get access to Bitcoin and the infrastructure companies.

So you're clearly not meeting their kind of needs. if you don't have a group that's looking at how to get this type of exposure. So you're really ignoring your customer. And so that's the institutional side. Now, if you think about the retail side, if you're an asset manager that's mostly catering towards a retail audience, just take a look at gray scale. I mean, gray scale is up to, what, $4 billion in AUM, the premium on the GVTC. They touch $6 billion.

Yeah, so it goes up another billion, I think, every time I check it. So it's in the premium that GBT is trading at, I think serves as a really good proxy for demand for the retail channel. So, you know, on one side, you have all these institutions that are going end around directly into this industry. And then you have these retail customers that are going the route of grayscale and bitwise and some of these other folks that are, you know, really like startups catering to this institution. Then, of course, you have fidelity, which has its own thing going on here. and there's probably the only traditional asset management firm that actually has made some strong move. So I think the next year is going to be a wake-up call for a lot of these by-side institutions. And, you know, the big challenge in my mind is not on the product strategy, because you could get a few

smart people in a room and you could come up with how this should work. But it's really a political issue where you don't have senior level buy-in at a lot of these asset managers. And that's what you need in order to push this through. I mean, these things are, there's a tremendous amount of career risk. Crypto assets is an incredibly nascent just category. And so you need to have that buy-in from the top. And I guess the last thing I'd say, just before I stop this rant, is, you know, it's one thing to miss a category. Like, it's one thing to be an asset manager and ETFs come along and you kind of miss that. Like, that happens. It's an entirely different thing if you miss an entire asset class. I think history will be written, you know, 10, 15 years from now that there will be asset

management firms that just became really large and dominant because they were early to digital assets. And, you know, that's Bitcoin. That's other public blockchain assets and that's probably security tokens at some point, too. But if you're just kind of ignoring this, then, you know, you just missed an entire asset class and when does an entire asset class come along. So you just can't miss this. So I don't know.

I don't know who needs to hear this, but like, Fidelity is going to eat your lunch. I guess is the overall message for these traditional asset management firms. So on the topic of security tokens, should we talk about INX for a little bit? Oh man. Yeah, this was like a really weird drama. This was a big scandal, big scandal on Bitcoin Twitter. I wouldn't even call it a scandal. Well, it was just a yeah, definitely a drama. So, you know, a few well-known bitcoinsers or advisors of I&X, which is a exchange. which is doing an IPO with a full SEC registration, everything. They've been at it for a few years, and they're selling tokens,

but these tokens are actually a right to a cash flow and a right to a liquidation preference. So these are very much security tokens. So this is kind of an interesting situation. I think it's a little bit unfairly maligned. That's kind of my perspective on all this. Because if you look at the pseudo equity tokens that came before, like BNB being probably the most popular example, B&B in theory is kind of an entitlement to a certain cash flow. It's a very poorly codified entitlement.

It's an informal entitlement because CZ keeps changing the white paper. It's not clear if they're buying tokens on the open. market, if they're burning them. There's no real disclosures. It's impossible to know if finance is actually burning the right amount relative to their revenue, whether they're doing what they claim, whether they're burning a completely arbitrary amount. And the investors, the token holders, have very few rights.

They have no contractual rights, realistically. But, you know, people seem to like BNB has a utility purpose. it gives you discounted fees at the exchange, and of course it has this, in theory, it has a cash flow associated with it. So, you know, fast forward a couple of years, INX is a fully registered and transparent version of this, where the token holder rights are strongly codified. There's a multiple hundred page prospectus, which I read. And the token holders there have a right to a cash flow and a liquidation preference. So they have a claim on corporate assets.

Now, I wouldn't say it's full-fledged preferred equity or anything like that. They don't really come with governance rights. So you could imagine it as kind of really junior form of equity. But, you know, I think this is important because it's kind of a template for how a lot of these tokens, which are clearly securities, should look, as opposed to the extremely informal white paper, which gets edited after the fact. Token holders don't know where they stand. They don't know what jurisdiction they're in.

They don't know if they can sue the team, if they commit the equivalent of securities fraud or anything like that. Here, those disclosure, those transparency, and it's very clearly laid out what the tokens give you. Now, I'm not saying INX is a good investment or not. We're not involved in any capacity whatsoever. I just think that as a potential model for an issuance of tokens in a way that's compatible with U.S. securities laws, it's pretty interesting.

And if you are going to issue something that looks like equity, why not do it in a registered way? You know, why not follow the rules? If you're going to create a cypherpunk project where those cash flow is relating for some defy project with no single leadership, then yeah, you're not going to want to register with the SEC that wouldn't make any sense. But if you are a corporation and you want to sell a token, which is an entitlement to certain cash flows or something else that looks like equity, you might as well do it this way.

Yeah, this to me was very silly. So, you know, people on the internet here were treating this like it was an ICO, an unregistered securities offering. And, you know, these guys went about it the right way. They registered it with the SEC. It's on a, it's on Ethereum. So I think that's why people were really bent out of shape, but it's on a private kind of instance.

it's on public Ethereum. It's just the things that are circulating on Ethereum are paper certificates. They could be circulating anywhere. It doesn't have to be Ethereum. And it's not a permissionless transfer on top of Ethereum. So it's really the blockchain piece of it is just an implementation detail. To me, this was kind of the equivalent of getting mad at someone around using like AWS instead of using Azure or something. It's like, who cares?

Yeah, there was perceived hypocrisy, I guess, on account of some of the advisors that have been Ethereum skeptics, but this doesn't really grant much credenced or it doesn't ratify Ethereum in any way. Ethereum is just a database, which is being used to store some of these claims. You could do it on liquid. You could do it on rootstock. You could do it on counterparty.

You could do it on any number of places, RGB probably. Yeah, it does seem like a bit of a tempest and a teapot to me. Yeah, I thought that was strange. So speaking about kind of implementation details for things that are happening that are real world assets, the Boston Fed is evaluating 30 different blockchain networks in the context of looking at a digital dollar and what type of infrastructure that would be built on. What do you make of that story?

Yeah. I don't know why a digital dollar would need a blockchain necessarily unless they, I guess maybe if you wanted it to interoperate with crypto financial infrastructure, That would be my best reasoning. But I kind of figured that if they made a Fed coin or whatever, it would just be running on their own server with no need to be distributed out to a network of nodes. Yeah, it's always been puzzling to me. But I guess you're right. If they wanted to have it ride on the public infrastructure that's been laid down for crypto assets, maybe that is a reason.

That wouldn't have been a good reason in 2015 to focus on blockchains, but now this crypto financial infrastructure of exchanges and wallets and various other tools which plug in is so ubiquitous that maybe now it would make sense to have a blockchain-based digital dollar. But that's only true because the crypto industry is so big. That doesn't vindicate blockchains necessarily. Yeah, so we'll keep an eye on that. One thing that I did not get a lot of attention this week, but I wanted to get your take on, was this case, this court law case.

So there was a decision in Archer versus Coinbase. Basically, the setup here is that there's a customer who had 350 Bitcoins at Coinbase and wanted to get credit for Bitcoin Gold. basically was suing Coinbase because Bitcoin Gold was worth whatever it was when it forked, and they wanted that kind of dollar amount. And the decision came down effectively saying not your keys, not your coins. You know, you have the ability to pull your coins off before a fork, but Coinbase as a company does not need to honor forked network coins. Like they don't have the right, they don't have to honor every single fork, which is, you know,

just totally common sense. But I think fork policies are definitely something that all of the custodians are thinking about. But this was the first time that I had actually seen it argued in a court of law and the court came down on Coinbase's side. Yeah, I loved this precedent. I think this is totally the right interpretation. When you consign your coins to Coinbase, they're not custodying a specific set of private keys for you. They have a big old omnibus account and you have a claim on some of the, you know, the Bitcoin, for instance, that you deposited. So, you know, I think one issue in 2017 was users that followed this theory, uh, that exchanges had to honor every last fork and they harangued exchanges into honoring them. That kind of legitimized

a lot of these forks because the exchanges would then have to do a lot of work to get access to those forks and give the users those forked coins. So, I think this is great, actually, because it means that it frees exchanges from the burden of doing a lot of work to support these forks, which is great because you shouldn't be able to impose engineering work on someone just by forking a chain. Most of these forks are completely irrelevant. So I think this is totally the right decision, and it drives home that the exact point. If you want full discretion over what your keys are being used for, don't hold them with a custodian. you know, take control of them yourself. And of course, there's competition amongst the brokerages and exchanges around the time of a fork.

So I remember when Bitcoin cash happened, I think it was Cracken was one of the first ones to add it. They had it almost immediately. So I'm sure a lot of folks moved their assets over to Crack in ahead of the exchange. But this just seemed like a common sense judgment to me. So Bitco has filed with NYDFS to become a New York trust. company. They're already operating as a trust company in South Dakota. What's your take on this? Yeah, I thought this was interesting. I actually saw this a couple weeks ago on the New York Department of Financial Services bulletin and then it was reported this week in Coin desk. So Bicko is already

operating as a trust company in South Dakota, which a lot of folks in the industry kind of view the South Dakota qualified custodian status is maybe inferior to the New York one. I think that would be safe to say. I think there's a lot of folks that question whether or not that's really kind of a robust framework and whether or not a lot of institutional pools of capital could get comfortable with that. I'm not going to say that we have the definitive answer on that, but I think that's the perception that we're hearing in the market. And this to me is an interesting move that mirrors the approach that Fidelity and Gemini and Paxos and I believe Coinbase, a number of other firms are kind of going this New York trust route. You know, New York is definitely, in my opinion,

the most difficult jurisdiction in the United States to navigate through. And this is a fairly well understood kind of trust company framework. So, you know, to me it just says BitGo would feel more comfortable moving under New York's framework, maybe in addition to the South Dakota framework. There's another question kind of back to our conversation last week around Crackin and all the stuff that's going on in Wyoming. The big question there to me is if this Wyoming special purpose depository institution, this effectively this new banking type in Wyoming takes place, will New York's Department of Financial Services honor reciprocity? So, you know, will you be able to operate in New York if you're cracking and you have a speedy?

That might be like a court case. I don't know if there's an answer to that. That could be contentious. I think a lot of people watching that development are expecting that to be litigated at some point. It would be kind of preposterous for New York to just say, you know, they do honor that reciprocity. and other kind of arrangements, it would be really interesting if they just said, no, we won't honor that.

I mean, that would be fairly unprecedented. New York has a monopoly in these things. They want to be the central node in the financial system. So I would love to see how that unfolds, and I think we will. Might be sooner rather than later. Yep. We also had quite the announcement

from Jerome Powell today, instead of having inflation target 2%, they are going to allow inflation to average 2%, which apparently is totally different. But effectively what it means is that if inflation, if they undershoot the target for a while, they'll attempt to overshoot it for a while to compensate so that it averages 2% in the long term,

which effectively means that given that we've been undershooting, we can expect a more inflationary environment in the not too distant future. And then of course, as he's speaking, CNBC pops open the Bitcoin chart, says Bitcoin USD reference rate powered by coin metrics right on it. And as he's talking, the Bitcoin price is just going up. That was a pretty epic juxtaposition, although it is worth noting that Bitcoin then fell subsequently.

So it wasn't an enduring effect on Bitcoin. It actually became kind of a news selling event. just I think we're living in unprecedented times here. The thing is that these kinds of crises are generally deflationary, and so when it says they want inflation, that's kind of another way of saying they just want a healthy economy where people are spending money, you know, and dollars are circulating, which is how you get inflation. The Bank of Japan has been trying to inculcate inflation for decades now. unsuccessfully because they've kind of a shrinking and aging economy.

So you can always manufacture inflation if you print a truly obscene amount of money. But I guess what they want is inflation, which is brought about by really hot economic growth, which it doesn't look like we're going to get in the near future. And I don't think anybody wants stagflation, but that might be what we're in for. Yeah. Well, it's going to be fascinating. I think this was a really, this was a fun morning just to see that chart pop up in the middle of this speech. It is interesting to see them shifting the tone now.

And I think the inflation expectations still don't take into account what's likely to become permanent, direct handout style stimulus to individuals and households in the U.S. They'll be billed as temporary initially, and then they'll be permanent. that's the kind of thing that's direct issuance into the economy because those funds get spent. So that's high velocity issuance, my opinion. Yeah, Yang was like a year too early with that. If he came across now, everyone would have just said, well, yep, that's kind of makes sense. It's completely normalized now. Yeah, bipartisan.

Speaking of that, did you see that the Bloomberg article, the title of it was investors hoard gold, Bitcoin and whiskey to soothe inflation fear. I don't know about you, but I've never really experienced whiskey to be something that is stored value for me over time. I've never been able to store it for a long period of time because I just drink it. Yeah, it tends to disappear quickly. Yeah. I think whiskey.

Let's take amazing discipline. I mean, a good bottle of whiskey definitely holds its value, though. Right. It doesn't become any less. tasty was time. I guess, but like, who is hoarding those? I think the guy I mentioned in the article had like 5,000 casks of whiskey at a facility somewhere.

And so what's the theory that you're just drinking like one a week? I don't think you're meant to drink them. I think you're meant to save them for future resale. I don't know. Where's the fun in that? Yeah. It's a good, I don't know. I feel like whiskey, Bitcoin, Gold is going to out of performance.

form of the next decade. I think it'll beat T-bills. I like bourbon. I also like Mezcal. We have a friend that has a Mezcal company. I feel like Mezcal has been that drink that's on the cusp of breaking out for decades now and it never has. Well, it's like soccer. It's like soccer is the sport of the future and it always will be. You always say this about soccer, but soccer is the most popular sport in the world.

So that never makes sense to me. Well, Mezcal, it's about to have a moment. heard it here first right so next week we have a couple of episodes that are focused on defy so we're going deep on defy next week yeah so we finally we decided to you know actually reckon with this phenomenon and see what was going on there so we were talking about to the architects of a decentralized exchange with a pretty novel structure

and we're talking to call davies of three chad's sorry three arrows capital all right everyone so have a great weekend Thank you.