Unchained - Bitwise's Latest Plans to Get a Bitcoin ETF Approved - Ep.143

Episode Date: October 29, 2019

Hunter Horsley, cofounder and CEO of Bitwise Asset Management, and Matt Hougan, global head of research at Bitwise, describe their vision for Bitwise, its current funds and indices, as well as how it handles things like forks and airdrops. Then they give their reaction to and interpretation of the SEC disapproval of their Bitcoin ETF proposal, as well as what their focus will be now to try to get a Bitcoin ETF approved. We also discuss their general thesis around how the crypto space will develop, whether or not indices and funds around the top 100 assets will ever make sense, their ideas on how to value these networks and whether or not the company would ever try to compete in the DeFi space. Plus, don't miss our conversation on Bitcoin IRAs.  Thank you to our sponsors!  Crypto.com: http://crypto.com/ Kraken: https://kraken.com CipherTrace: https://ciphertrace.com/unchained Episode links:  Bitwise: https://www.bitwiseinvestments.com/ Hunter Horsley: https://twitter.com/HHorsley Matt Hougan: https://twitter.com/Matt_Hougan Unchained interview with Spencer Bogart: https://unchainedpodcast.com/spencer-bogart-on-the-20-trillion-in-store-of-value-assets/ Bitwise 10 Private Fund fact sheet: https://static.bitwiseinvestments.com/FactSheet/bitwise10/Bitwise-10-Private-Index-Fund-Investor-Class-Fact-Sheet.pdf  Bitwise 10 Offshore Index Fund: https://static.bitwiseinvestments.com/FactSheet/bitwise10-offshore/Bitwise-10-Index-Offshore-Fund-Investor-Fact-Sheet.pdf Grayscale Bitcoin Investment Trust: https://grayscale.co/bitcoin-trust/ Bitwise Ethereum Fund: https://static.bitwiseinvestments.com/FactSheet/ethereumFund/Bitwise-Ethereum-Fund-Investor-Class-Fact-Sheet.pdf  SEC order disapproving the Bitwise Bitcoin ETF proposal: https://www.sec.gov/rules/sro/nysearca/2019/34-87267.pdf Matt on CNBC discussing the Bitcoin ETF proposal: https://twitter.com/CNBC/status/1181309471349526530?s=20 Bitstamp/BitMEX trading manipulation: https://twitter.com/DoveyWan/status/1129246233917382656 Jake Chervinsky’s tweet about how the SEC is unlikely to approve a Bitcoin ETF under Chair Jay Clayton: https://twitter.com/jchervinsky/status/1182149164177608704?s=20  Unchained interview with Jake: https://unchainedpodcast.com/all-things-crypto-regulation-with-jake-chervinsky/ SEC commissioner Hester Peirce’s dissent to the disapproval of the Winklevoss Bitcoin ETF: https://www.sec.gov/news/public-statement/peirce-dissent-34-83723 Van Eck’s withdrawal of the Bitcoin ETF proposal: https://www.coindesk.com/vaneck-solidx-withdraw-bitcoin-etf-proposal-from-sec-review Chris Burniske on how to value these networks: https://unchainedpodcast.com/how-to-value-a-crypto-asset/ Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shin. Heads up, everyone. In case you missed it, a few weeks ago, I rolled out a new feature on Unconfirmed, a weekly news recap. This summer, through my survey, you listeners said you'd be interested in a weekly news recap on the show. So now you can listen to my take on the top stories of the week after my guest interview at the end of every Unconfirmed. Go subscribe now to find out what I think are the top stories in crypto each week. Cracken is the best exchange in the world for buying and selling digital assets. It has the tightest security, deep liquidity, and a great fee structure with no minimum or hidden fees. Whether you're looking for a simple fiat on-ramp or futures trading, Cracken is the place for you. New regulations just rocked the crypto world. Attend the virtual asset travel rule compliance conference and hackathon in San Francisco this November fifth and sixth, join industry experts and top technical minds to learn about cryptocurrency compliance

and collaborate on the open source solution that preserves privacy. Crypto.com. Get their app and buy crypto at true cost with no fees or markups. Get a metal MCO visa card with up to 5% back on all your spending. Want more? Download the crypto.com app today. My guest for today are Hunter Horsley, co-founder and CEO of Bitwise Asset Management and Matt Hogan, Global Head of Research. Welcome, Hunter and Matt. Hey, Laura. Thanks for having us, Laura. Disclosure. BitWise has been a sponsor of my podcasts in the past. Let's start with your backgrounds. Hunter, why don't you go first? How did you come to phone BitWise? Sure. So BitWise got started in 2017. Prior to that, I was a product manager

at Facebook, before that at Instagram and before that at the Wharton School. And I think like many people in San Francisco in in 2017. Sooner or later, someone says to you, hey, do you remember that Bitcoin thing? And, you know, I'm not an OG crypto person. I'm 2017 vintage, but I had bought some in the past. And so when a friend actually from the Wharton School, who was at a hedge fund, said that, we took a look and saw what was going on. And at first, we were actually arbitrage trading back in 2017. There were pretty widespreads. And that's not what we do today, a bit wise,

but it's what sort of gave us a reason to pay closer attention to the space, to start meeting people building blockchains, to start reading about different protocols, dealing with some of the frustrations of investing in the space and deciding if this is something we wanted to root for. And of course, we ultimately decided it was something that we wanted to contribute to and make a large part of our careers. And we saw the opportunity to do that with Bitwise.

And so we started the company in 2017. And how did you comment with the idea for the company? Like, what was your vision for what you wanted to build? Yeah. So an experience that we had in 2017, we were, as I mentioned, trading our own portfolio and naturally having conversations with lots of friends and peers, about crypto. And one of the things that surprised us was that a lot of people who are tech savvy, financially confident had a common remark, which was, you know, I like to invest, but it's too

complicated. And, you know, I don't know how to figure it all out. And some of the people who had that viewpoint in 2017 end up being served by hedge funds. But a huge portion of investors in America, invest through a financial advisor. In the same way that you turn to a doctor to help you through health, you know, mainstream Americans, wealthy families, individuals, partner with a financial advisor who helps them with their investments, helps them understand what they should be doing relative to their financial goals. And we saw that there was no one who was, you know, focused on those people and that part of the market. That part of the market generally invests through mutual funds and ETFs and index funds and closed end funds and interval funds.

And so we saw the chance to build something that opened access for a part of the market that wasn't in a position to use products like Coinbase or Cracken, but also doesn't conventionally use venture funds or hedge funds. So that's what we saw. And Matt, how did you come to Bitwise? What was your background? I was actually introduced to BitWise by my good friend Spencer Bogart. who you know from blockchain capital.

Who was a recent guest? Who was a recent guest? The funny thing about Spencer is that I think I gave him his first job in the financial industry. So I hired him as an analyst when I built a company called ETF.com. So I got involved in the ETF industry in 2003 and built the largest media conference and data business in that space over a period of about 12 years. We did a lot of firsts. We built the first ETF data service, the first ETF analytics and rating service. We subsequently sold that business to FACSET. But in the process of building that, I hired a team of analysts, and Spencer was one of those analysts. I helped put him through the CFA series of exams. And then he went on to do these great things in the crypto space.

So after I sold ETF.com in 2015 and 2016 and then didn't earn out, I was looking around for the next big, disruptive area of finance, the next place where I thought I could help a little bit with providing good quality information. And Spencer knew Hunter, and Hunter was looking for people who had expertise in indexing in ETFs to talk to. And so Spencer put Hunter and I together. I had coffee, was tremendously impressed with the team that Hunter had built. I thought the product that Bitwise was building was the only rational product for the vast

majority of investors who want access to crypto. And so that began a process. And I was, fortunate to join the day after my, my earnout expired on my previous company. So it was a great experience, building etf.com and excited to be part of another, you know, big disruptive area of the financial ecosystem. So lay out for me what it is that Bitwise does and what your vision is for what it could become. Yeah. So the way we think about what we're doing, Laura, is, is we want to open access to crypto as an asset class for a subset of investors who today don't have an on-ramp. So if you think about the different on-ramps or ways you can participate in the asset class today, there are the exchanges and apps like Coinbase, Crackin, Gemini, BitStamp,

and so on and so forth. And those are really well suited to individuals who are making decisions about their own investments, as well as traders, individuals who are either hobbyist or, you know, professionally day trading. On the other end of the spectrum, you have venture funds. You know, you had more hedge funds in 2017. It's moving towards venture funds today in 2019, who, you know, are professional active managers and the preferred tool of endowments in other institutional allocators. but in between, as I mentioned a little bit before, you have the vast majority of mainstream Americans who work with a financial advisor. And the advisor can't use a mobile app. They can't use a web platform like Coinbase Pro.

They also generally don't use venture funds. What they use are products like mutual funds, ETFs, index funds, and so on. And so the goal that we have at BitWise is to help mainstream investors understand and benefit from this asset class. And so that's partially about the products that we built that allow them to include it in portfolios. So we have a family of funds today that serve independent financial advisors, which are sometimes called RIAs, multifamily offices, family offices and wealthy individuals. And then what comes with that, though, it's not just about the features of the fund, but also being a partner to those financial advisors, analysts, CIOs, and so on and so forth.

because there's so much to understand and so much constantly changing about the asset class. But it's such a small allocation relative to the rest of the portfolio. And then, of course, everyone has other things going on in life. It can be a lot to keep track of. And professionals never want to be caught flat-footed. So a huge part of our responsibility in the relationship we have with clients is to make sure that they're always informed of what's going on and have the information they need to successfully participate in the asset class.

And so we manage a family of funds. And then we put out quite a bit of research, have lots of meetings and other sessions to help accomplish that. Yeah. And I just tack one thing on, Laura, because it's important. It also speaks to why I joined Bitwise a couple of years ago is that the primary product we offer is an index-based strategy that's market cap weighted. And the beauty of that is that the people we're talking to, the people Hunter is talking about

the financial advisors who don't allocate 100% of their time toward crypto or 100% of their portfolio to crypto, but use it as a small piece. Those people, and in fact, I'd say most people in crypto have a generalized belief that crypto and public blockchains are going to be more important in the future than they are today. But they don't have a specific belief about which particular asset is going to be more important. Is it all going to be on Bitcoin?

Is it going to be on Ethereum? Is it going to be on something else? And what the index strategy allows them to do is to make a bet that if crypto is more important in the future than it is today, they'll be rewarded without having to get into this asset versus that asset, which are questions that, quite honestly, they're not prepared or equipped to even investigate or have an opinion on. And even if they did, it's a very hard question to ask. So we're trying to make it easy for people to have exposure. I wanted to ask you how you make this decision because for your main index, I guess,

and fun, which tracks the top 10 crypto assets. Like if I were to, do a quick comparison between the list of the coins on that versus either coin market cap or like on chain FX. You know, I see like, you know, for coin market cap, ripple, finance coin, Bitcoin SV, Stellar, and Tron are all missing. And I'm excluding tether because it's a stable coin. But, you know, for the Bitwise 10, you guys have Cardano, dash, Zcash, Manero, Ethereum Classic. But then like on coin market at Zcash is at 30 and on chain FX, it's at 33. So how do you determine which coins make the cut? There are two important things we do, and I think they're both very important. The first one is to screen out coins that we don't think can be safely held by institutional investors.

So there are a group of coins. Tron is one, Bitcoin SV is another one, where it's really difficult or possibly impossible to do offline transactions with those coins. And therefore, having a true cold storage solution is at least, it may be impossible. At the very least, there's not widespread community belief in a single solution. And so as a result, holding those coins in a fund or an index would expose people to the risk of loss because they can't be custodied in the same way that other assets can be safely custody. So that's an example of how we screen out certain coins.

There are other screens for liquidity. We insist that coins trade on more than one exchange. so that if an exchange shuts down, the liquidity doesn't vanish. So there's a screening out process to remove coins that can't be safely held, and we aren't sure can be safely traded from now and to the future. And then the other piece we do is what's called an inflation adjustment. So one thing that separates crypto from traditional markets like stocks is that crypto assets are under a phase of continual issuance, right? There is more Bitcoin today than there was yesterday.

And so the difference you're seeing with something like Zcash is that there's a lot more Zcash being issued every day. And so what we do is we project five years out into the future to get a view of how much of a particular asset will exist in five years and use that our market cap reflection with the idea that the market understands that Zcash's issuance is increasing rapidly and therefore it's discounting the price. And so you have to make that sort of inflation adjustment. The end goal is to capture all assets that can be safely held, that can be safely traded, and to capture it in a way that reflects the market's true understanding of the importance of those chains. And so those are the screens that get us to that end goal. One other thing I was curious about is, so you guys have this Bitcoin fund and there's also an Ethereum fund. For the Bitcoin Fund, how do you differentiate that from, like, for instance, the Grayscale Bitcoin Trust? is it really just the same thing, but like a little bit cheaper?

Like I noticed the expense ratio is cheaper. Yeah. Yeah. So, you know, for some clients, they have a very specific view about Bitcoin and want to pick that specific exposure. The Bitwise Bitcoin Fund has a few distinctions from something like GBTC. First is that it's open-ended. So you can invest in the fund and then you can liquidate your investment on an ongoing basis. GBDC is you're likely familiar if you invest in the fund. There's a one-year lockup, at which point you can resell it through the over-the-counter markets

to a retail buyer who then may pay you or historically has paid a premium. So the retail buyer on the brokerage, if they're trying to buy $10,000 of Bitcoin, they pay $13,000 for it. but if you invested in the private placement, you're locked up for that year, and there's no redemption. So you're sort of accounting on that retail investor in the Berkage market wanting to buy the shares from you in a secondary. That product is obviously very popular. Our product, which also gives you exposure to Bitcoin, just operates differently. There's no second market for the shares.

You can invest in the fund with us, and then you can redeem from us, and you can do that on a weekly basis. So that's one component. And then the second component, it has half the price of GBTC. And so you caught that as well. Yeah, but the one thing is like the fee is still kind of high if I think about it in the broader scheme of things. Like if you compare to mutual funds and exchange traded funds where fees are often below 1%. Like, why are your fees? And it's just for Bitcoin. It's not even like anything really fancy. Yeah. So there are two things that come to mind. First, it's worth noting that. that our products are priced with an expense ratio, which is a unitary fee. So just to save one sentence more on this, you know, for a venture fund or a hedge fund, what you have is a management fee, which, you know, might be 2%.

And then the custodial prices, the administrative prices, those are also charged to the fund on top of the management fee. And so your all-in fee is something above the management fee. For index funds, the convention is to report an expense ratio, which is an all-in fee. So the amount that Bitwise takes is a subset of the expense ratio of the fund, and that includes custody and other things. So that's one thing that I mentioned is that that's inclusive of custody, which as you're familiar with in the space, has historically been quite a bit more expensive, orders of magnitude more expensive than in stocks or fixed income. The second thing I would say is that I think to all of us on this call, crypto is, a very, you know, familiar subject matter and thought space. And Bitcoin feels very straightforward at this

point if you've been in the space for over a year. But to the vast majority of people, even Bitcoin is still very intimidating. And our goal is to price it in such a way that we can be very available with research, to take meetings and to sort of be, you know, I think for clients, today, they would rather have the best heart surgeon than the cheapest heart surgeon. And so even though in things like S&P 500 index funds, they're looking for sort of the cheapest option in crypto, which is new, esoteric, complicated, not their full focus, they'd rather pay more and get more hands-on service. So that's how we've, that's the second component of what goes into how we price the product. Okay. And one quick question before we move on to the ETF issue, which I'm sure is what everybody wants to hear about.

But I was curious for these funds. How do you guys handle things like forks or air drops that occur with any of these assets that are in the fund? Sure. I can take that one. And I just add on the fees front, you know, maybe the more apt comparison is to something like emerging market or frontier mutual funds, which often have fees above 1%. And as Hunter said, you know, people want the best heart surgeon in this space. In terms of airdrops and hard forks, so our policy on air drops is pretty simple. at least historically and particularly recently, there have been no meaningful air drops that have been worth the risk of gathering and liquidating. If there were one, we would do that. On the hard fork front, we evaluate each hard fork when it occurs. We monitor the trading of each new asset. And if it's safe for us from a custodial perspective to realize a hard fork, we'll do that,

and then we'll liquidate it and the proceeds get distributed. So, yeah, we make sure that our investors are exposed or get the full benefit of hard forks, but we do so in a way that we check to make sure it can be done safely from a custody perspective. The other thing I would add, Laura, on this front, and as it pertains to some of the earlier questions about what ends up going into the index, is that it's a public set of rules that governs what's held in the fund. And so on our website, bitwiseinvestments.com, you can click.

and actually read through the full public methodology document that stipulates, you know, all these different rules. And again, they're all striving to give investors exposure to the asset class while making sure that it's holding things that are at a level of maturity that's feasible for it to be done securely to expect future liquidity and so on and so forth. And there's actually a governance board that also influences the rules of the index and Matt sits on that board, the former head of indexing for Bloomberg, former head of research for SMP, who sat on the S&P, who sat on the S&P 500 index committee for 10 years sits on that board, and actually Spencer Bogart sits on that board as well. So there's a public set of rules. We're not just sort of making

ad hoc decisions here. The spirit of those rules is, again, to weed out some of the things that might appear highly ranked on a website, but don't have the characteristics that make it safe for a mainstream investor, and then those rules have governance so they can change over time if need be. And the last thing I would add is we also intervene if there are ad hoc events. So when EOS announced its main net launch back, I think it was June 6th of last year, they were going to launch the main net, which meant that they were going to freeze trading for a period of time. We convened and rolled it out of the index because liquidity is a requirement of being in the index. So when there are things that sort of happen suddenly, we convened to address those as well.

Okay, so yeah, let's move on to the SEC decision, because this is what everybody wants to talk about, I'm sure. I want to hear what your response is to the SEC's 112-page rationale for why it did not approve your ATF application. Sure, yeah, I'll take first pass and you can add on Hunter. You know, really we're extraordinary pleased that they went to 112 pages worth of depth. into their view on our application and the pathway forward is that the real risk in this process would be that we'd get back a cursory review that didn't lay out what needs to happen in order to move the ball forward. And that's that's not what we got.

We got 112 pages. Some of them toughly worded. But importantly, they laid out a pretty clear path for Bitwise or other providers to pursue if they wanted to, if they wanted to advance things. If you think back over the course of ETF applications that have been on file, this is really the second major response. The Winklevoss paper got, I think it was 96 pages. So we edged them out by a couple dozen pages.

That was a great step forward for the industry as well. It showed that the particular path that they were taking was not the path. The SEC wanted to see. They didn't like the idea of pricing on a single exchange. They thought there was risk that the ETF would overwhelm that market. And they raised this specter of how you might move forward, which is to search for a regulated market of significant size that could trade alongside the spot Bitcoin market. So our application took that and ran with it. We argued that the CME Bitcoin futures market was a regulated market of significant size.

And what the SEC came back and said was that the results were inconclusive. They need more data. They need more data on where price discovery occurs. and they possibly need more surveillance sharing agreements with underlying spot Bitcoin exchanges. But the important thing was, you know, they really were very clear in terms of what analysis they need next for us to move the ball down the road. And that's what we intend to do. Yeah, I actually want to dig into those points a little bit because I actually thought a lot of what they said here was like they had very strong arguments. I'm just going to pull out a few of the ones that

kind of struck me. So for instance, they said that your report, you know, because you had kind of separated out the real, the exchanges with real volume versus fake volume. And they said that, like, you know, you were then assuming that, like, for instance, significant volume on new platforms would be fake or non-economic volume. There was another one where they said that your rationale for assuming that the volume in the OTC dark pole market was like not significant was also. So flimsy, they objected to the fact that you excluded the South Korean exchanges because of capital controls.

And what they said here was, you know, that doesn't mean that the trading volume in South Korea isn't real. So like those were just, I mean, there were like a bunch where I was like, yeah, like, good point, good point. But those were just a few that caught my eye. So what is your response to some of these particular things and like how would you restructure your proposal going forward? So I think Mac can try them in on some of those topics, but I just want to sort of establish the context as the backdrop is, this is productive. You know, we file and then try and present the information that we think will be supportive of the things that ultimately they want to get comfortable with before they say, okay, we're signing off on having diligence to this. And we make an attempt to do that in the most useful way, but we want to hear feedback. So, you know, it comes through this sort of back and forth.

But to Matt's point before, what's important is that there is feedback and that it's granular and that we can act on it. It doesn't need to be the case that, you know, that everything we put forth was perfect on, you know, on the face of it. And so I think that the really, you know, important thing for us was that we got a lot of feedback on where we should be focused and the things that resonate and things that didn't. That's what we got. So how would you address some of these points that I brought up?

Those are great questions. I think, and some of them were great points. Some of them we have a huge amount of additional data that we'd like to provide. I think the argument we are trying to make with the fake volume piece was a relative size argument. We were saying, look, fake volume is a well-established problem in the crypto market. It's not that Bitwise is the only firm that's investigated this. A number of firms have looked at this and agree that there's a huge problem.

with fake volume in the market. So what we did was try to systematically analyze it and say the actual Bitcoin market, the actual spot Bitcoin market is not so big. It's significantly smaller. And as a result, the CME futures market looks significant. So our point was that when you scaled the Bitcoin spot market appropriately, the CME futures market was about 20 to 40 percent as big. And our view was that that relative size argument,

showed that it was significant. Well, the SEC actually said that... Right, right. But right, no, but I think the SEC was saying that the, that there's, that you didn't provide enough evidence for them to know what the real size of the market was because, like, for instance, this issue about like the gray area between real and fake, like you did concede that on some of these quote unquote fake exchanges, that some percentage of that volume must be real, but you didn't know what it was. And so the SEC was like, there were multiple points where they were.

They were saying, like, you didn't actually prove that you know what the real size of the market is. That's absolutely right. Yeah, that's absolutely right. And they also wanted... So then you can't say that you know that the CME volume is significant. Do you know what I'm saying? I do know what you're saying. I'm actually going a step further.

So they asked for additional data, and we'd be happy to provide that data. And some of the points, as I said, that they made were valid. But what I think the important thing was, actually, if you read through the entirety of their response, is toward the end in the last 20 pages where they effectively argue that the relative size argument may not be the winning argument, that even if we had convinced them that the real size of the market was X and the real size of the CME futures market was Y, they're not sure that that would solve their problem. It could be that even volume on or even reported volume on fully fraudulent exchanges or totally fake volume could still influence the price. So the direction they're actually pushing

is to do analysis on prices from across the spectrum to find out where price discovery occurs. And that's almost regardless of whether we convince them that the size of the market is X and not Y. So there's a huge amount more data that we can provide on the size of the market, and it would be great to have more independent third-party verification. And some of their arguments I just sort of fundamentally disagree with or think missed the point. but those are almost almost not what they want to see going forward. What they want to see going forward is, regardless of what you're saying about the fake volume, for all these places that are reporting prices, where is price discovery occurring?

And they laid that out pretty clearly at the tail end of the section, which focused on the question of what is a significant market. So there's great work to be done, but there's this nice pathway forward. Okay, so let's discuss that in a moment. but first a quick word from the sponsors who make this show possible. Crypto.com sees a future of cryptocurrency in every wallet. Have you seen the MCO Visa Card? A metal card powered by crypto.

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where are you thinking that you then will go for your next proposal? Yeah, yeah. We're researching it right now, and Hunter, feel free to jump in. But they laid out, you know, the phrase they use, the sort of magical phrase in their response is the word lead lag analysis. Lead lag analysis, you can think of if you have two exchanges and they're both tracking the same thing, say Bitcoin,

which one goes up first and the other one follows? is the exchange that leads. That's one way of looking at where price discovery occurs, if you examine two exchanges. There are other academic ways of looking at it as well. But what they're trying to, the sort of goal is to find one or more regulated, surveilled markets that collectively are where the majority of price discovery occurs in the market. So that's one avenue of research that we're going to pursue, and I assume that's one avenue of research that other people have looked at

this are going to pursue. Well, we, I'm sorry. And so how is that different from how you, you know, identify those 10 exchanges? I guess like not all of them are regulated, but. So, so we, we looked at it through a relative size lens, which Matt referred to before, which as we said, you know, what is the amount of volume taking place on exchanges that we can conservatively say have real volume? And, you know, and then what are the, you know, the comparative sizes of those markets? And CME is very large. I think what Matt was just conveying is the SEC had some comments on the methodology there. You know, maybe certain things should be included or not. Great. We can make changes there. But moreover, that regardless of relative size, they're also interested in understanding, again,

regardless of size, where does the price go up first? Or where does it go down first? Does it go up on Coinbase first and then Gemini follows and BitStamp follows and Binance follows? Or does it go up on Cracken first or so on and so forth. And so that's the lead lag analysis that Matt's describing and that they're saying, regardless of how much volume is taking place on different exchanges, they'd like to have a clear understanding of where the price is forming first that then gets arbitraged and traded into the rest of the market. Right. Right. And that gets to their sort of core point, which goes through the history of ETFs that they've approved, which is you need to be able to have a surveillance sharing agreement between the exchange where

the ETF is listing, in our case, Nizzi Arka, and a market of significant size that's regulated. And the significance is driven by is that market, a market where price discovery occurs. What the SEC is trying to prevent is someone being able to manipulate, say, the Bitcoin market, on a market that cannot be surveilled. And that's the difficulty that they're worried about. And that's the sort of research that we're pushing towards to solve. Yeah, and I was wondering if that concern was sort of proved out this summer with that situation that happened with Bit Stamp and BitMex. I don't know if you guys followed that. Yeah, we're basically a trader placed a large order in BitStamp to crash the price there. And because I guess BitStamp's price is referenced for Bitmex, that enabled the trader to essentially probably make a killing with a short on Bitmex. And so I know this is like a little bit different because BitMex isn't. you know, one of the spot exchanges, so it's not exactly what you were looking at. But, you know,

I just assume that, like, that sort of proves the SEC's point that you can engage in similar tricks. Is that, is that true? So I think the general thing of where does the price move first is exactly the right. Yeah, you're thinking of the right thing, which is, you know, if the price moved on bitstamp first, and that's generally the case, then they want to understand that bitstamp tends to be the venue where the price moves first. And so that that is the nature of what they're, what interested in understanding better. Right. Yeah. Importantly, you know, BitStamp has a bit license, which has market surveillance requirements built in. So the ecosystem, and this is a point I've made a number of times, is evolving rapidly. And what was true two years ago is no longer

true today. So there's increased regulation of a larger number of crypto exchanges. There's the potential for surveillance sharing to occur on those exchanges. There's at least sort of the regulatory requirement through the BIT license for surveillance to be mandated on number of those exchanges. So, yeah, you have to look at both the activity and then the ability to surveil and consider and review what happened on those exchanges. That's really what the SEC is concerned about. Oh, okay. Oh, interesting. So I actually, so we've been kind of talking, you know, about these spot markets, but I actually want to flip sides because, as you probably remember, back in July 2018, when the Bitcoin, the Winkle vows Bitcoin ETF decision was made, SEC Commissioner Hester

Perce wrote a dissent where she basically said, like, look, the SEC shouldn't even be focused on the underlying Bitcoin spot market at all. And she said that to her mind, the correct interpretation of the Securities Exchange Act of 1934 was that the exchange should determine manipulation on the exchange traded product itself, but not in the underlying market. And she said, quote, indeed, if the disapproval orders rigorous standard were applied consistently, many commodity-based ETPs would be in peril. So do you agree with her there that the SEC kind of like incorrectly and inconsistently applied this standard? I think that ultimately, The commissioners that sit today are focused not on protecting investors going forward.

So I think that there are some people who make arguments that, you know, oh, well, you know, this product from the past is pretty ugly. You know, how then can you not give a Bitcoin product a chance? But, you know, I think the commissioner sitting today are focused on going forward. How do we make sure that investors are protected? So I think some of those arguments resonate less well, even if there is merit in some of them, because they want the future products and future actions to be bulletproof. So you think it is correct for them to have focused on the underlying spot market? I think it's fair and reasonable.

I think Commissioner Pierce's argument is also interesting and reasonable. But the way to think of the SEC is almost the way to think of the FDA, They're a first do no harm regulator. They want to make sure that retail investors are protected. And to, you know, if we backpedal a few years, I think even Bitwise would agree that the Bitcoin market was not ready to support an ETP. There were no regulated and insured custodians. There was large arbitrage gaps in the, in the Bitcoin market.

So it's not like they're asking inappropriate questions. We obviously think the market has matured to the point where it can now fully support. an ETP, but, but, but again, I think they're getting after it for the right point. And I wanted to also ask about this Van X, Solid X decision to withdraw their proposal rather than wait for the rejection from the SEC. So I was just curious, like in the days leading up to the decision about the Bitwise ETF, did you kind of like, you know, know already the outcome, but decide not to withdraw? Or did you not know the outcome? And so you, you know, that's why you didn't withdraw or, you know, in general, like how much in the dark

were you guys throughout this whole process? Our view was that we wanted to get 112 pages from the SEC. So we didn't know what would happen at the end of our review period. But our view was that either outcome, either approval or disapproval with detailed commentary, would be a major positive step forward. And that the only negative outcome would be if we didn't learn anything from this process about how we move forward. So we were happy to take it all the way through to disapproval to get these 112 pages of feedback because they form the foundation of what happens next, both in our efforts and the broader industry's efforts to move forward on the ETP question.

Yeah, that's exactly right. One other thing I wanted to ask about was after the decision, Jake Trevinsky, who's the general counsel at Compound and he's also a former securities lawyer. He tweeted, quote, at this point, it's reasonable to assume that Jay Clayton's SEC will never approve a Bitcoin ETF. His term ends on June 5th, 2021, but could go another 18 months or longer. Usually we'll, 18 months longer, usually we've seen new ETF proposals filed immediately after rejection, but it might be time to take a year off. Do you guys agree with Jake? I don't, I don't agree. And I'd be curious. for your thoughts, Matt. I mean, I think our experience of the staff and the commissioners has been that they're open-minded. I mean, even if you just contrast, Commissioner Clayton did an interview with Bob Pisani on September 9th. And Bob said, and Bob interviewed Jay a few times and said, you know, Jay, are we ever going to see a Bitcoin ETF has any progress been made? And Jay said the short answer is yes, but there's still some questions. There's still questions that after you work through. So I think our experience has been that that they've been,

collaborative and are definitely listening to points that are being made and are honing in on their argument. I mean, for example, just even last year in 2018, a lot of the focus, you'll recall, I mean, Laura, you in particular will definitely recall everyone was talking about qualified custody, qualified custody, how could you possibly custody these assets, what is a qualified custodian? And you'll notice that that's absent from the focus of the 112 pages where the SEC lays out where, you know, the things most on their mind today. So I think that we've seen, we've seen definitely that they're attentive, that they're open to hearing arguments, they're going to give you a strong feedback. And to take it, to take a step way back, you know, we're talking about,

you know, Bitwise wants, wants to introduce an ETF to open up the market to mainstream investors. I think for everyone in the space, you know, crypto is a, is a pretty new space. And I think the things that the SEC is calling attention to, certainly they have bearing on an ETF, but I think for anyone who's involved in crypto as an investor, not just a user, they're bringing attention to issues that need to develop, that need to mature if investors want this to really grow into a mainstream and institutional asset class. I mean, I think even for people who are comfortable investing on Coinbase's mobile app or another venue, I think they'd all like to see more liquidity, more institutional participation, you know, a higher market cap. For those things,

things, you know, more regulation. For those things to happen, the issues that the SEC is calling attention to need to see improvement. If the industry stays it is today, you know, I think many of the people in the market today expect and want that improvement. All right. So one other thing that I wanted to ask about was like early on, it sort of feels like the SEC practically kind of spelled out what they needed to get a Bitcoin ETF approved. And they harped on this idea that there needed to be at least one significant regulated market for trading futures on the underlying commodity and that the ETP listing exchange has to enter into the surveillance sharing agreement with that market. And you sort of alluded to this, but like I just wanted to know,

like, you know, now that you know this, how is this going to inform your next proposal? Sure. That's a great question. It can be more than one market, to be clear. So the CME futures market is one example. The new backed market is another example. You could consider ETPs and other jurisdictions. And at least in the 112 pages, it raised the specter of having market surveillance agreements with the actual underlying spot exchanges. It doesn't have to be a derivatives exchange. It just has to be a regulated market of significant size. So as you think about where we and other people go forward from here, I think the goal is to build up one or a group of exchanges where you can have surveillance sharing agreements in place, such that you feel confident that those are the

significant markets where price discovery is occurring. The continued growth of the CME Bitcoin Futures market is going to be part of that. Backed may be part of that. Other exchanges may be part of that. But that's sort of where the magic answer for the SEC lies is to have enough of the market be regulated and surveilled with sharing agreements in place. For them to be. to feel comfortable that that market manipulation won't occur without it being able to be investigated, corrected, and enforced. So we've gone really deep on your products, and we've also obviously now covered this Bitcoin ETF.

But I want to kind of take a step back and ask you about your thesis, about how the crypto space will develop generally. Because, so we've got the people who say there will be one chain to rule them all. There are others that say there's just going to be a few valuable protocols. But like even if I look at your 10 large cap, um, crypto fund, it's just like, okay, there's a strong argument to be made for Bitcoin and Ethereum. Like for the others, uh, you know, I, I, I'm at a little bit of a loss. Maybe if you really stretch it, you could like add Manero.

And, you know, I'm not saying I, I don't doubt that like someday we'll end up with at least a few more significant chains, but like, do you think that we'll really end up with 10 really big ones, you know, and if so, like, is that going to happen in anything less than like a decade, you know, and then yet you've also got like this index for the top 100 and stuff like that. So, you know, but those coins are even less, you know, kind of proven. So what does the future look like to you? And like, you know, why are you kind of laying the groundwork for these products that it's just at this moment not clear at all that like anybody will really even consider those quote unquote investable assets? Well, so,

So the first thing, we have indexes that people use for benchmarking for the Bitwise 10 large cap, the Bitwise 20 midcap, 70 small cap, and 100 total market. But in terms of funds that people invest in, we only have the 10 large cap and then the Bitcoin and Ethereum fund. But you do ask people to contact you if they're interested in, like it seems like you've changed the interest in. Yeah, yeah. So we're always interested in knowing how people want to access the market. I think that, you know, the uncertainty that you're describing is the main point, Laura. So our large cap index holds a huge proportion of Bitcoin because that's, you know, the most

developed and highly valued public blockchain today. Some people think that there will be competitors. Some people think that there are edge cases that could impact Bitcoin. And other people think that that's, you know, that's the steamroller that all of the value will consolidate around. and you could deal with that uncertainty in one of two ways. You could have a lot of conversations, do a bunch of reading and then pick which side you fall on, or you could run a strategy where you benefit in either case. And that's what our index strategy provides for investors. If in 2014, they thought that Bitcoin would be the only thing and never could they imagine something like Ethereum.

And so they only held Bitcoin, then they missed out on the opportunity of Ethereum. But, you know, it's possible that we, so it's possible that we'll see other really valuable and useful public blockchains. It's also possible that we'll see consolidation around some of the larger ones we have today. I would just tag on to that. My view of how the crypto market is going to unfold is, sounds like it's very similar to yours, Laura. I think there'll be a handful of very important coins that are sort of generationally important. I think it's highly likely Bitcoin and Ethereum are two of those. but I think there'll be a couple more with various particular use cases.

The beauty of the index strategy, because it's unconstrained, because it doesn't cap the weight of any particular asset, is that it evolves naturally to invest more and more in those assets as they become more and more important. So I think it's entirely possible that, you know, 10 years from now, there's even greater concentration in the top, you know, five or six assets than there are today. but I don't know exactly which those assets will be.

And so the reason we have 10 is it captures enough assets to let you sleep easily, knowing you'll be exposed to whatever is becoming the winner in the space. And the reason we don't constrain the weights the way some other indexes do is because we realize that this could be a winner-take-all or a winner-take-most market. And so the strategy is sort of optimized around that. So do you have thoughts around how to value these different crypto assets? Because as I'm sure you're aware, there are a lot of different ways people are trying to analyze these, such as the NVT ratio, the network value to transactions ratio, which is basically network value divided by USD volume. And there's other ways, you know, Chris Berniske has actually been on my show talking about how he uses the equation of exchange, MV equals PQ. as a way to analyze them. So what are you guys using when you try to value these networks or like what is your thinking

about how best to do that? So those are all well-known approaches to valuing assets. There are others like technical analysis, looking at sentiment. I think the reality that everyone in the space is aware of is that there's no one agreed upon fundamental today. And ultimately, the underlying dynamic is a solid. supply and demand's dynamic. So if demand outpaces the amount of new supply coming online through the block rewards, then the price goes up and and vice versa. And this is one of the reasons that

people look with such high anticipation to the having of the Bitcoin block reward next year, where every year instead of the little under 4% of the total supply being mined, it'll drop to a little under 2%, which is almost the difference between the rate, which, which silver is mine dropping to the rate at which gold is mine. So that's the underlying. Hunter, how do you, I mean, so the supply and demand thing is so simple that even like a pump and dump scheme then could look like a valuable investment at some point. Do you know what I'm saying? It's like, because there's a lot of ways that a lot of these different projects are actually gaming that idea. Yes. So that's, you know, ultimately what creates volatility in the market is,

is it is a function of supply and demand. And even though supply changes at a constant programmed rate, the demand changes at different rates, again, based on, you know, there might be one trader who's looking at technical analysis. There might be somebody else who's looking at an NVT ratio, and there might be someone else yet who's not really looking at any of those things, and is just buying it for the qualitative thesis that this thing will be more important in the future than it is today. And that creates an inconsistency in the amount of demand or buy orders on any given day, and that creates the volatility. I think that there's no silver bullet answer here. I don't expect it in six months the industry will arrive on, you know, a price

earnings like a way of valuing assets. In the same way that, you know, if you think about residential real estate in your city, somebody might say, well, the most important thing is the view, and somebody else might say, the most important thing is the bathroom. And somebody else might say, the most important thing is the block or the neighborhood. And somebody else might say, well, the most important thing is the macro economy and how many people are actually moving each year. And all of those things have some amount of merit. And I think that that's the difficult reality that crypto assets, as digital commodities, have in terms of being valued, which is you have to try and construct a view about future

demand. And then the supply piece for most public blockchains is more straightforward. But I don't anticipate anytime soon the market that's, you know, trading agreeing on one one metric to create a floor around. Yeah, no, I think that's right. I would just add, both for myself and for most of the investors that we talk to, they see this not as a short-term holding, but as a long-term investment. And if you think about something like Bitcoin as a long-term investment,

the addressable market it's going after, even as just the first digital store of value, is so much larger than its current market capitalization, right? It's 50, 100, 200 times the current market valuation. that you're really talking about how much you're discounting the likelihood that it achieves that place in the world. And there's so many factors that go into that discount, you know, the regulatory factors, political factors, technology advancements, wallet adoption, custodial developments, adoption, ETF approval or not.

All of those have their own sort of discount rates. You know, most of the people, I think of that, I think, just look at something like Bitcoin or or Ethereum or some of the other assets and say they're so early and they're going after such large markets and the discount rates currently are so large and the variables, you know, so many, that it's really hard to assign any particular value. The important thing is just to make a small allocation to the space and hold on to it for the long term. The fortunate thing for investors is that it has these wonderful benefits that come with that allocation in terms of it. it not having correlation to the other assets in their portfolio in terms of the ability to

rebalance on a disciplined basis. But, yeah, valuation targets are really hard. I think the important thing is the addressable market that these assets are going after are huge, you know, orders of magnitude larger than their current market capitalization. And that's the thing I think investors should keep in mind. And Bitwise is going about its strategy in a very traditional way, a way that's recognizable to somebody who has had a career in finance. And meanwhile, we're seeing a lot of experimentation in the defy space where it looks like smart contracts could very well do exactly what it is that you guys are doing with your funds and indices.

So do you ever see yourselves going in that direction? Like, would you ever offer smart contract versions of your funds? Or like, you know, what would that even look like? Yeah, I think there's a ton of exciting things being developed in the defy component of the industry. I almost sometimes feel like there's almost two different parts of the crypto industry. There are people who are really pushing the envelope in what's possible. If you think about compound and die and some parts of defy. And then there's firms like ours that are sort of trying to, you know, still trying to introduce public blockchains and Bitcoin and crypto to the world for the first time.

And to answer your question specifically, you know, absolutely, we'd be open to structuring a solution. in whatever way, best empowers, you know, the audiences that we are seeking to serve to be able to participate in the asset class. Today, I absolutely do not think that that's a smart contract. Understanding Bitcoin is in and of itself still a complicated project for most clients and many investors. And the last thing they want is to also complicate the structure that they're using to get exposure to that asset. But I do think that it makes sense for some investors. And if over time, it becomes a better and better mechanism, then there's no reason we'd be opposed to it. A lot of people were excited about the launch of backed, and you would often see on Twitter people

would be like, when backed, but then of course when backed actually launched, it was pretty anticlimactic. So what do you, why do you think that was? And, you know, how does that affect Bitwise's business in the sense that I feel like, you know, that's a sort of similar market to you guys, or at least the target market. Yeah, I think I can jump in there. I mean, I think there are two reasons why it was anticlimactic. First, expectations have gotten way out of hand, right? If you look back even at the CME and CBOOE futures markets when they launched, their initial volumes were very small. People were disappointed. The reality of futures contracts is they take time for liquidity to build in the market and particularly for something like BACT, which wasn't even approved at a lot of national futures wirehouses. So there were a huge group of investors who, couldn't even participate in that market. And I think it's way too early to write off backed, just like it was way too early to write

off CME or CBOE when they had very tepid volumes in December 2017. The other reality is it's tough to be second to market in the future space. And so there are technical differences between the CME contract and the backed contract. One settles physically. One settles for cash purposes. But for major uses of futures like arbitrage, short-term. holding, that difference doesn't make that big a difference. And so you have a new futures contract competing with an existing futures contract. I go back to my ETF days where the first ETF to

market in any area tends to get the lion's share of the assets. And it's very difficult for second to market ETFs to nibble into that market share. They can do so over time, but it takes a lot of time. And I think that's true here. You know, the futures market tends to be a monopoly market back just trying to eat into the CME's lead by having a differentiated contract and physical settlement. But that's going to take a long time to play out. So I think it's too early to read it off. I also think they face more challenges than maybe the market anticipated. I do think conversely, when you look at something, either like private funds or an

ETF, those are still undeveloped markets. So I think there's significant demand for a crypto ETF because it will fit into the workflow of financial advisors, which control about half the wealth in the U.S. and currently have very limited allocations to crypto. So I think the market just got ahead of its skis on backed. And I think, you know, if we look at this in a year, we may be telling a different story. I've said this a few times, but I think it's just constantly important to remind ourselves that as people working full-time in crypto, there's so much going on.

We take it very seriously. For an institutional allocator, this is not their top priority. So even for the institutions, be it asset managers, hedge funds, who will end up taking advantage of BAC's future contracts, they have other things going on. The only convene is an investment committee every so often. And so it's not the case that the sort of scrambling to invest on the first day that a product launches. It's important that the door is now open for that tool to be something that they can use. But generally speaking, institutional allocators are not moving at the pace of investment products, but that's they're moving at their own pace.

And so once the investment products are an option, they start, you know, they can consider them. So I think there's, you know, there are a lot of people who will be interested in the, in the back futures who just, you know, didn't come in on day one because they had other things going on. And that's something we constantly encounter with our client base, by the way, which is, crypto is less so, you know, it's less so that Ethereum is competing with Bitcoin or a hedge fund is competing with a venture fund and more so that crypto as an asset class is

competing with, you know, domestic equities, international equities, emerging markets, high-yield debt, investment-grade bonds, munis, you know, that make up 99, 95% of people's portfolios. So, so I think that that is important to, yeah. That got me curious because I noticed that, for instance, your Bitwise 10 private index fund became available in November 2017, and the returns have like pretty much all been negative ever since. So I just wondered, you know, do you feel like, like are you noticing that your LPs are sort of expressing regret for getting in?

Or like, is it hard for you to attract new LPs or like how has this crypto winter sort of affected? We've had inflows every week for almost two years. Of our existing clients, something like 20% have increased their exposure. the retention of clients who've been invested for over a year is north of 95%. I think for clients in our funds, it is a bit more of an intentional investment than, it requires more effort and intentionality than, you know, say, buying or selling some Ethereum on a mobile app. And our clients generally have a thesis, and that thesis is generally, you know, a multi-year

time horizon. So that's what we've seen play out, which is, investors topping up when prices come down, generally, you know, the vast majority of investors still in the fund. And then new investors have come in every week for almost two years now. We've seen more interest amongst professional investors, you know, mid-2018 through today than we did in 2017. So there's been some shift in the audiences that are most excited about crypto. But that's what we've seen so far. And the other thing I would note, Laura, that's important, is, you know,

funds have an inception date, but returns depend on when you invest in the market. So an investor in Bitcoin who bought at 18,000 has a different return over the last two years than an investor who bought it at 4,000 in 2018. So there are people since 2017 who have very positive returns. Right. One other thing that I wanted to ask is, so obviously you guys are working on this Bitcoin an ETF, which would then enable people to put or have exposure to Bitcoin in a tax-advantaged account and put it toward, for instance, their retirement. But I was curious about these other products that are already out there, like this, I noticed there are these Bitcoin IRAs.

Describe how this work and give us your take on those. Oof. Go for it, Hunter. Yeah. So there's some products out there that, uh, that the market themselves is helping you put crypto in an IRA, and then they facilitate the purchase, and then the custody of that crypto into your IRA.

They're not funds, so it's better to think of them as brokers or services. You know, I think both Matt and I, and if you ask many other people in the space, have a certain amount of frustration with some of these services without naming specific ones, you know, one of the most popular takes something like a 10 or 15% upfront fee. So if you're, you know, not reading the fine print, you go to invest $10,000 in Bitcoin. They take $1,500 to buy it and then put it in a custodian for you. And then the custodian charges you a custody fee. So the positive lens is

crypto is a very new space. And anyone who is working to increase access so that not just tech savvy individuals or, you know, the financially-savvy. can participate, ultimately we're a fan of. So anyone who's trying to bring new options. But sometimes the options are less than optimal. And it can be hard for individuals to discern when they're dealing with a new service provider or a new product that they've never heard of before. Sometimes there's a bit of a mismatch and they're not well equipped to farewell in that

interaction. So I think there are some, and this won't come as a surprise to most people, there are definitely some services in the crypto space that I would say are a little bit predatory. Our view is that for the vast majority of mainstream Americans, it will make sense for them to work with their financial advisor in the same way that they work with their financial advisor for every other asset class. They work with the financial advisor for high-yield debt. They work with them for investment-grade bonds, for small caps, large caps.

And it's exciting and necessary that there's a lot of enthusiasm to learn about crypto and to take action yourself. But I think for it to become a sustainable asset class, it can't be the case that, you know, every, you know, investor is picking investment solutions themselves, deciding if they think EOS or Ethereum has more merit, if they think that, you know, Bitcoin is dead and Ripple is king or Ripple is dead and Bitcoin is king.

I think there's a lot of, you know, exciting things to think about. But I think that ultimately, be a sustainable asset class. It needs to converge on roughly the same set of ways you approach other asset classes as well. So to bring it back to the specific providers, there are providers out there. It's great that people are working to create more ways to participate in crypto, but some of them do have what I would consider fairly predatory promotion and then fee structures. Yeah, yeah. The one I learned about took 15 percent, and I was like, oh, okay, so it's like highway robbery. Yeah, it's pretty mind-boggling. That's really not, you know, that's, I think there's no way of

looking at that in which you say that that's, that's anything other than fairly predatory. Yeah. All right. Well, this has been a great conversation. Where can people learn more about both each of you as well as Bitwise? So the website is Bitwiseinvestments.com. The firm is on Twitter. Bitwise Invest. I'm A. H. H. H. H. H. H. H. H. H. H. H. H. H. H. H. H. H. Hogan on Twitter. And yeah. Great. All right. Well, thank you both so much for coming on Unchained. Thank you, Laura. Total pleasure. Yeah, thanks for having us. This was fun. Thanks so much for joining us today. To learn more about Hunter, Matt, and Bitwise, check out the show notes inside your podcast player. If you're not yet subscribed to my other podcast Unconfirmed,

which is shorter, a bit news year, and now features a short news recap. Be sure to check that out. Also, find out what I think are the top crypto stories each week by signing up for my email newsletter at Unchained Podcast.com. on. Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Youne, Daniel Ness, and Josh Durham. Thanks for listening.