The Breakdown - Nic Carter on How to Make the Best of a Bear Market

Episode Date: June 11, 2022

This episode is sponsored by Nexo.io, NEAR and FTX US.    NLW is joined on “The Breakdown” by Nic Carter, the founding partner at Castle Island Ventures. In this conversation, they discuss the market cycle, what’s valuable about being in a bear market and the promise of decentralized finance on the Lightning Network.    Find our guest on Twitter: @nic__carter - Nexo is an all-in-one platform where you can buy crypto with a bank card and earn up to 16% interest on your assets. On the platform you can also swap 300+ market pairs and borrow against your crypto from 0% APR. Sign up at nexo.io by June 30 and receive up to $150 in BTC. - NEAR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NEAR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Find out more at NEAR.org. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “Catnip” by Famous Cats and “I Don't Know How To Explain It” by Aaron Sprinkle. Image credit: Rob Mitchell/CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, June 11th. And today I am sharing an interview recorded during Consensus at the CoinDesk podcast studio presented by Oak Network. Thank you to Oak for their support. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation,

come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Finally, a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. My guest today is Nick Carter. He is a venture capitalist at Castle Island Ventures, one of the most articulate and thoughtful people in the Bitcoin in crypto space, and a strong

voice of skepticism around many aspects of the crypto industry. However, I think that you'll find that Nick is more complex than just being disinterested in anything other than Bitcoin. This is, as you would expect, a great conversation that I think that you will enjoy. All right, Nick, welcome back to the breakdown, sir. How are you? Doing good. This is actually somehow the second podcast I've recorded from an active sort of Expo Floor. This seems to be an increasingly popular concept. It's a new thing to me. I'm like in a fishbowl again. There it is. Well, from the fishbowl, I'm excited to get your take on a number of different things. Last time we talked, I think we were probably, you know, in a crescendoing bull market.

I think obviously we're in a very different place now. We just got inflation numbers, a surprise to the upside. Let's just start with your take on market cycle, where we actually are. in terms of descent down, settling into a bear, all that good stuff. Yeah, you know, can you believe, you know, I thought once upon a time that cycles were obsolete and that we had transcended the cycles, that's not true. I believe the super cycle theory, you know, that maybe all these markets would work themselves out. We wouldn't get the crazy reflexivity.

And it would just be a gradual ascent up to heaven. That didn't happen at all. Turns that we're not, you know, we live in a broader context. We're not immune from the dreaded macro, right? We were very beholden to it, in fact. And maybe we're more of a risk asset than we thought, disappointingly. Although that can change. But yeah, you know, with regards to crypto, I would say, you know,

the amount of sort of graft and malinvestment and usually general Ponzi-like behavior is so significant that there has to be a huge, huge, huge. washout now before we can kind of reset. And I think the psychology of the market has to reset, retail has to become fully disillusioned, exit the markets. You know, some of these institutional firms that plowed in near the top of the last cycle, they have to get disillusioned. So we do need this long reset. And I don't think you can turn the psychology around in an instant. So, you know, I think we're looking at sort of a U-shaped longer trough here until our, you know, rate hiking cycle, maybe reverses, until the psychology, the market can reset. And I think that'll

take a long time. So, yeah, I think it could be analogous to a 2015-16 situation or a 2018-19 situation again. Yeah, I think people don't appreciate sometimes just how, just the human side of markets in terms of that reset and the recalibration. And I mean, look, it's taken us like six months to accept that were like actually going down in a steady pattern into a bear market. Like, yeah, this feels very much to me like, I mean,

I remember consensus 2018 when there was like, I keep thinking about it. I keep thinking about that exact conference. There were ICO mascots dancing around. The juxtaposition between the price action and the excitement was crazy. This feels like that. Yeah. That's interesting because obviously I haven't been down there.

So it's fascinating to hear. You know, I think that I was like, I don't want it to be totally bleak. I remember, you know, there's a lot of really important things that happen during bear markets as well, particularly in this sort of like nascent industry. So one of the questions I wanted to ask you is, what was your favorite part of the last bear market? And what do you think might be interesting or good or something you're looking forward to this time? Selfishly, my favorite part was that startup valuations were modest.

By the way, this is actually an important part of like the capital creation industry. like you can't have high valuations all the time and expect the grease of capitalism and new capital to continue to flow, right? Yeah. And, you know, when I started sort of institutionalizing building coin metrics, that was in the pits of the bear market. And getting a client, you know, and getting a dollar of revenue in the door was a struggle. It was a grind. Hiring people was a grind, right? Those are the conditions that I think make for great startups, actually. And I think in the, you know, riotous bull markets when raising, you know, a $100 million pre-money valuation and raising huge amounts of money, it's easy. And you have all these tokens that around. You can, you know,

easily onboard people. Those are the conditions for bad companies to be formed, right? And so, you know, from the entrepreneurial perspective, this is a complete cliche, but it's true. I think the companies that are founded and they're built in, you know, these really tough times, those are generally of a higher quality and they're going to maintain better capital discipline they're going to probably maintain more capital efficiency you just develop better habits and so from my perspective

we deployed Civ 1 entirely in that bear market and I'm very very happy with that cohort of companies there some incredible companies in there so we'll see what happens with valuations again but yeah that was my favorite thing about it is you can relax the cacophony isn't so loud it's not pandemonium all the time. It's not conference season all the time. You can actually,

you know, build genuine products. And not only that, you have a market pressure to do so in a responsible way. So from the perspective of capital allocation, you know, selfishly, I'm looking forward to the next year or so. And I also think that it's much, much healthier for the actual sort of corporate environment here. The other thing that I think was a notable feature of 2018, 2019, that just completely evaporated was you can almost track market cycles by what type of media people are willing to consume. So, like, it started with, like, you and Hasu writing narrative visions of Bitcoin. It's like, you know, like 3,000 word, like long-form pieces exploring narratives that, like, everyone read because we got, like, one of those every two weeks or three weeks. And it was like the thing that we talked about versus peak bull cycle and you have 13 Twitter spaces competing at the same time.

right? And it's something different. But the reason that I bring this up is that you guys, you and Alan Farrington and Ross Stevens from NIDIG just released a paper that I think is interesting in the specific and in the general. So it's a paper kind of about the UST fallout and what that means and just a reflection on defy. And one of the lines, the line that I loved was the concept of decentralized finance is powerful, noble, and worthy a lifetime of focused effort. And I think that it reminded me of one of the things about this type of bear market is is you get to reevaluate concepts from sort of first principal terms without assuming the words that meant something before mean the same thing now. What inspired that paper? What was kind of behind that? And, you know, I just love to dig into that a little bit.

Yeah, I wish I could take credit for that line. I think Ross Stevens wrote that one. It sounds like a Ross Stevens line. Yeah, yeah. You can actually kind of tell the three of us are very idiosyncratic writing style. So you can actually kind of tease it apart and see who wrote what. Alan and I actually have a kind of a sequel to that paper coming out, which is much more in-depth, specifically about Terra. But that first paper, the idea was, actually, it was Ross's idea, because Alan had written with a pseudonymous co-author, this piece called Only the Strong Survive, about a year ago,

which was a very detailed, long-form critique of some of the bad ideas in Defi. And then so the idea was to take those ideas and then look at them through the prism of Terra, which in many ways exemplified a lot of the worst ideas in Defi and then use that as a jumping up point for more general commentary on Defi. And I think it really is true. Like Tierra had all of the worst parts of Defi in it. Like it had fake yield. It had, you know, token-based subsidies.

It had naive sort of economic thinking with no, you know, reflection on sort of economic history or basically this like insular thing that happens in the crypto space. Crypto people think they're doing stuff for the first time, and it's never been done before in any other context. It had, you know, fake decentralization, right? It had false promises of pegs, basically magical thinking. And it had this sort of like idea that if the ecosystem is big enough, then, you know, that sort of bails us out and that will support valuations. It had like fake TVL and fake theories of valuation based on these bad metrics. So basically, Tara had all of the worst parts of defy.

in it. And so I think it's a great example to critique the bad parts of defy. And to be clear, you know, and if you read the piece, we're not writing off DeFi. Like, DeFi is great, right? A open composable financial infrastructure that makes open banking look closed. That is a powerful and important thing. And it is good for sort of consumer welfare. And then it will create a big consumer surplus. However, that's not to say you can't criticize it. And that's not to say that it aren't bad ideas held within it. In fact, it's full of horrific ideas, but it's because we like the idea that we're critical of it. And I think, you know, maybe in these bare market phases, we're afforded more of the space to be reflective. And so that's why I think the tear example

is actually really worth dwelling on, as opposed to just passing it off as, you know, an unfortunate blip or a failed experiment or something like that. Nexo lets you easily buy crypto with your bank card and earn industry-leading interest rates. Earn up to 16% on crypto and up to 12% on stable coins. Nexo makes passive income easy, with interest paid automatically and daily. With Nexo, you can also borrow against your crypto at 0% APR and exchange over 300 pairs. Receive a welcome bonus of up to $150 in Bitcoin until June 30th at nexo.io. That's nexo.io. This episode is brought to you by NIR, a climate neutral, high speed and low transaction fee, Layer 1 blockchain platform.

NIR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NIR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Reimagined your world today at NIR.org. The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets

with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use referral code Breakdown to support the show. So one of the places that you guys kind of leave the paper are around how some of these ideas might look in a sort of lightning powered world, right? You talk about live fire or lightning finance.

How much do you think the sort of differences there are builders in the space making different types of decisions and prioritizing different things versus constraints actually imposed by the system? You mean in terms of like why? Why the lightning kind of finance versions of, you know, yield, for example, are more interesting or have more long-term kind of durable potential? So there's a few reasons. I would say number one is just building on a stable foundation. So that's an obvious one. Bitcoin is fundamentally very stable. It's endured with very, very, very little downtime. I think in the last decade there's been basically known downtime. If you look at the underlying foundation, and we're talking about like, you know, potentially billions or even trillions of dollars worth of people's savings. You know, we can't really build these things on a brittle foundation. If you look at the other platforms upon which Defi has built, whether it's Binance smart chain, Tron, Solana, obviously Ethereum, which is undergoing its own transmutation right now, there's a huge amount of change, dynamism, and there's also a lot of fragility, right? These

things fail a lot because they're pushing the limits of sort of what a node can do. They're pushing limits of amount of data that you can push through a network like this. And so I perceive enormous fragility there. I perceive the risk of capture because many or most of these are proof of stake networks, which makes them eminently captureable, right, because it's effectively a shareholder governance model with the largest stakeholders can exert control. And so, you know, I'm leery of building long-term, you know, financial applications that are meant to be useful for people on these unstable foundations. You know, aside from that, then there's other sort of idiosyncratic features of sort of present-day

defy, which you probably wouldn't see in sort of a Bitcoin context just because of the cultural differences. Like, you know, the token-based subsidies is obviously a bad idea. Subsidizing liquidity with the issuance of typically an unregistered security, that's a terrible idea. It shouldn't occur. You know, maybe it's interesting. Maybe it's a quick bootstrapping method, but it's more trouble in its worth. I think. And, you know, lastly, I would say there's architectural differences. Like lightning is a true scaling win, right? You're pursuing the layered model. That's how the actual financial system works.

If you look at settlement systems versus payment systems, you always have ledgers and subledgers. You have layered scaling. For something like stablecoins, I don't know if you'd call them defy or not, you know, stablecoins originated on Bitcoin on the Omni protocol, then they migrated to Ethereum, then they migrated to Tron. and it was purely on the basis of fees. Those blockchains, they don't present true scaling wins. They just create more block space. Once they fill up, they're still going to have the issue with fees. We see this all over the place.

So I would say returning stable coins to a transactional system like Lightning, which does offer true scaling win in terms of stripping out that intermediate data. To me, that feels like I can't ordain anything to the market, but that feels like sort of the natural consequence here, whereby you can actually transfer assets on a network, which is a unicast network as opposed to a broadcast network where everybody has to store all the data all the time. That doesn't seem like it'll work.

Those are the three main contrasts that I draw there. We could dig into it. Maybe at some point we should do a whole show about that because I think it's super fascinating. But since we only have a few minutes in the context of this particular interview, I also wanted to ask you about your perception of the state of the regulatory discourse in the U.S. Maybe two questions.

One is anything surprising to you, either to the upside or the downside, around the Biden executive order? And then second, any first thoughts on the Llamis Chilla Brand Responsible Financial Innovation Act? The EO, to me, looked somewhat impotent. I mean, TBD on that, I guess.

It seemed more like an information gathering campaign. If they have plenty of information, I don't know if they're going to make any better decisions. To me, it seems like these are actually normative questions, not descriptive questions. How do you regulate the financial industry? That's not a question of, like, you know, what's happening? That's a question of what do you want to happen?

What kind of values do you want to instill? Do you want to be tougher with regulation? Do you want to stifle innovation? Is innovation bad when it's in the context of finance? So, you know, I think that really is a matter of the sort of legislative clout that the Biden administration has here as we progress to the midterms, which, you know, based on the inflation print and the other data we're seeing, it doesn't look like it'll be very favorable for the Biden admin. So the EO, I'm not too worried about. I am seeing this general trend of sort

of capture. I mean, if you look at the new NYDFS guidance around stable coins, what that would do is, you know, they create some standards for stable coins issued under the New York trust charter or any DFS regulated entities, that basically creates barriers to entry for stable coin issuers. It makes it more expensive and there's a lot more compliance involved there. Maybe that's good.

You know, maybe stable coins should be highly regulated. But that basically just reduces the overall vibrancy in a space like that. And so that's sort of the general trend I'm seeing is like capture, create regulatory bears to entry, you know, make it more difficult to operate in this space, whether you're in exchange, whether you're some sort of intermediary custodian or, you know, a stable coin issuer. Now, with the Jillo brand Lummus build, I think that's one of the most impressive pieces of legislation I've ever seen.

There's a lot of good ideas in there, whether it's the de minimis tax exemption, whether it's putting something like Bitcoin firmly under the aegis of the CFTC, whether it's creating a serious rules-based test distinguishing securities from commodities, these are all great ideas. Does it have a chance of passing in this next legislative session? Absolutely not. If there's a red wave in November, will it have a chance? Maybe. I think what we'll see is a lot of these ideas will make their way into other bills probably on a piecemeal basis. But as far as an initial proposal, this demonstrates a mastery of the crypto industry and the problems we face and the problems that need resolving. So I'm considered me very impressed. Now, you know,

do Lummis and Jillabrand have the cachet within the Senate to push this forward? I'd be shocked if they did. But ultimately, these are good ideas. And so to the extent Congress is able to internalize that, I think we might actually see some of these ideas expressed in legislation. But that's all conditional probably on both the House and the Senate being united on the Republican side after November. Yeah, I think it's an interesting and important point to recognize that

these types of texts do create foundations for future legislative efforts, right? I mean, even the idea of sort of, you know, ancillary asset is now a thing that everyone who's going to propose new legislation going forward or who looks at where the SEC ends and the CFTC begins is going to have to consider. And, you know, all of a sudden there's going to be debates around those lines with this new framework rather than just it's how we're not, you know, which I think is super powerful. As we close out, just to have a little fun with it, because we're going to be dealing with it for a long time. What have been the most surprising or mind-numbing new critiques that have come as the critical set gets emboldened as we slink into the bear?

You know that I'd love this question because this is like my full-time hobby is like identifying these and making fun of them. By the end of our time in this industry, I'm going to have like a full slate of Nick Carter Fudd products, you know, like a FUD bingo card. I got the original Fudd dice. I owe you guys some new merchandise. Exactly. I found a very funny one, which was like, if Bitcoiners were so right about inflation, how come Bitcoin sold off? It's like, you know, like, look, I don't control the price. Okay, all I can do is just try and understand the macrodynamics.

That one cracked me up. Someone tweeted that to me this morning. I would say the craziest one is this New York Times article that just came out like two days ago, based on an unpublished academic paper, a manuscript. It's not even peer-reviewed, not fully. published in any journal, saying, you know, the authors identified 64 major miners in the early, early days of Bitcoin, 2009, 2010. And on this basis, they say, oh, you know, we've traced most Bitcoin transactions with, you know, six degrees of lineage. You know, we looked at the genealogy

of Bitcoin transactions. We found that most people trace back to these 64 miners. So Bitcoin's not anonymous and it's very centralized. And they also say that these miners, some of them controlled 50% a hash rate back in 2009 or 2010. And so, you know, they were very altruistic and they chose not to attack Bitcoin. And thus, Bitcoin's founding myths are flawed and the decentralization is fake. And this got like a glowing three, four thousand word right up in the New York Times. It's like a completely preposterous thing. It's like the stakes are extremely low. What happened in 2009, 10 is almost irrelevant today. I mean, Bent mining doesn't resemble that at all. The analysis wasn't novel. They didn't de-anonymize these people. They just clustered them based on their activity on chain.

So, yeah, that one was grossly perturbing because clearly there's some sort of agenda. There's some sort of PR firm maybe that the academics used here. The paper is not notable. So why does it get a front page, literally front page print edition mentioned in the New York Times and a glowing multi-thousand word write-up? Even though it's not saying anything novel, you know, like that one was really weird. And I'm still, trying to understand how that came to be. Yeah, I agree with you. That definitely gets my vote at this point because it's like...

Weirdest new fud, like completely unexpected. Because there's no new data being presented. It's like, yeah, we knew mining was pretty concentrated. That's not new information. Well, it also lets like, I don't know how to read. Like, so one, the idea that it was super concentrated at the beginning, like their analysis chose to only go up to the point where Bitcoin was worth a dollar. Yeah.

I mean, the only transaction was worth a dollar. transactions that had happened with Bitcoin during this period are Laslo buying pizzas, which, as you every year point out, it's my favorite theory of this, is Satoshi being a little annoyed that he was hoarding so much because he was GPU mining. And so maybe it was a way to redistribute some of it back into the system. So you have that, that's what's going on. Like, this is the state of those times, right? Where like, Satoshi's like, you know, up in a Laslo's ear or whatever. And I was trying to kind of verify this like conclusively and I didn't quite get there. There had not up to that period been a mainstream mention of Bitcoin.

The first time it showed up in like Newsweek or Time was something like late 2011 or 2011. 2011 would have been the earliest. Yeah. And so it's like you're talking about a period where the only place that people would have heard about it is through their personal networks, you know, more or less. Coinbase wasn't in Y Combinator until the summer of 2012, right? Like this is like, this is very early. So you have like not surprising at all.

And then like their main conclusion is like it would have been really easy to attack but they didn't. It's like, okay. There was no treasure, right? Bitcoin would have been worth at most $3, 5 million at the time. There was no merchant activity. So like a 51% attack requires defrauding a merchant, right? Like there has to be a service rendered that you are then withdrawing the payment that you made for, right?

You're tricking someone to give you something in exchange for a payment, which you then withdraw. That's what a 51% attack is. A 51% attack isn't just reaching into the chain and pulling out. out money. You know, that's not how it works. So there was nothing to attack. The stakes were low. So of course they didn't attack because there's no incentive. There was no treasure. So the whole thing is just mystifying. Nick, it's always great to have you on the show. As we wrap up, what's one thing that you think people should go read or think about as they settle into and accept the bear market? I would, I guess shameless plug. Read my piece with Ross and Allen. And then I have

another piece with Just Allen coming out probably today. Well, I don't know when this is going to come out. maybe it'll be out already. And, you know, reflect on some of the bad ideas that powered the bull market now that maybe we've a bit of time to think. I think that would be my advice. Reflect on the metrics that we use for valuation. Reflect on sort of the somewhat unsound theories, underscoring a lot of these things. And, you know, reflect on the fact that a lot of these structures that are incredibly popular

in the crypto space, I'm not going to name names, are built on Ponzi dynamics. I think we have to be honest about this. otherwise we're just going to keep making these same mistakes. And it's okay to call something a Ponzi if it is. So maybe let's try and not focus on the Ponzi's as much and focus on sort of really actual, you know, useful things. That would be my advice to people. All right. Cheers, sir.

Well, thank you so much for your time and go have fun and sweltering Austin. Thank you. All right, back to NLW here. Just reflecting on that conversation a little bit. If it wasn't clear, I think that there are, lots of potentially healthy things about bear markets and the reflection they afford. I love this notion from Nick and Ross Stevens of decentralized finance the concept rather than the practice or application. Indeed, in general, I like the idea of debating concepts rather than terms.

Mostly, I just want to say a quick thank you to Nick again for being on the show. Even if I ever find areas where I disagree, I always feel more considered and thoughtful for having heard Nick's take. So thanks for hanging out. For now, One more thanks to my sponsors, nexo.io, NIR and FTCX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.