We Study Billionaires - The Investor’s Podcast Network - BTC024: Plan B & Adam Back on Bitcoin Contango & Derivatives (Bitcoin Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, everyone, welcome to this Wednesday's release of the podcast where we're talking about Bitcoin. On today's show, we have two of the biggest names in Bitcoin, and that's Dr. Adam Back and our friend Plan B, who developed the popular stock to flow model. On the show, we talk about the current market consolidation. We talk about potential impacts of the growing contango trade, what's causing the contango trade, Bitcoin fungibility, and much, much more. So without further delay, here's my chat with Plan B and Dr. Back. You're listening to Bitcoin Fundamentals by the Investors Podcast Network.

Starting point is 00:00:39 Now for your host, Preston Pish. All right. Hey, everyone. Welcome to the show. I'm here with Plan B and Adam Back. And we're just going to have a fun casual chat here. So I want to start it off by just saying we're seeing a pretty decent correction right now. So as we're recording this, the price of Bitcoin is down to 49,000.

Starting point is 00:01:09 300, it got almost to 65,000. So this is about a 26% correction from the high. And, you know, for people that are just participating in this for the first time, this is probably freaking them out. And you guys are, you guys have been in the space for quite a while here. So I want to capture your opinions at this particular moment in time just to allow people to kind of hear your thoughts and how you think about this. I mean, so going back a few years, There was a long period where there were inverse bots. The price would sort of drop a bit, you know, wait a few days to a week, so people succeeded to get their wire transfers, and it will go straight back up again.

Starting point is 00:01:51 I think that was considered to be to leverage trading liquidations or something like that. So I was in a habit of buying these things. And where I ended up, obviously, if you spend your money too soon, then it corrects further. You kind of run out of money and you don't get the benefit. So at that time, a few years ago, I generally wouldn't even. and buy a dip unless it was 20%. So that was just, you know, I tried 10%. I always buying too early kind of thing.

Starting point is 00:02:16 So, okay, let's up to the 15, up to it to 20. But the volatility is kind of lower now. So I'm all going for sort of 10% stuff. And of course, there are a nice graph showing the corrections during previous ball markets where it's had, I don't know, a dozen or some pretty decent number of or 25 to 35% corrections during a period where Bitcoin increased, I don't know, like a factor of 100, right, from $200 eventually about $20,000. So I guess that's one of the things about trading Bitcoin versus of the things.

Starting point is 00:02:51 You just have to adapt for a volatility. I was almost thinking that people should, you know, try to divide it by 10 or think in log scale or something in terms of what's normal if a stock ferries and you believe in its confidence. just buy a bit more or hold it, doesn't matter kind of thing. I think you just have to adapt for that. Plan B, your thoughts? It reminds me very much of the boom market in 2017, where we indeed had a lot of dips like this, 20, 30% minus.

Starting point is 00:03:23 For example, the Bitfinex exchange was hacked at the time, that caused a big dip or the fork wars when I think it was Roger Veer coming up with that fork, Bitcoin Cash. and it always feels like the end of the world every time. And it's, well, the thing, if you have lived it before, so if you have gone through a crash and the bull market before, then you can be rational and you can remind yourself that it's like Adam says, you have to have this volatility because otherwise, yeah,

Starting point is 00:03:57 everybody would jump in and be a millionaire. This is not for the week at heart. And the volatility is what gets you, the return as well. I think the correction we see at the moment was a long overdue, because we have gone up from 10,000 to 60,000 in a short period of time. And lots has happened, right? Biden with its capital gains tax of 49%. Amazing. Turkish government banning Bitcoin, a government or an exchange in Turkey getting hacked, the whole mining events in China with hash power dip, it's bad news after bad news. So I guess it's just one of these things that

Starting point is 00:04:36 had to happen and that will make the floor even stronger for the next jump up. So I'm quite happy with it. Yeah. I mean, I think the mining hash rate drop was interesting. So I have some theories about that one. I think people who are less familiar with mining read too much into it. So there's three factors there. One is the most of the graphs you find online showing the hash rate are actually extrapolations from very low samples of a highly variable, highly random data point, which is the time between blocks. Of course, it varies, you know, from one minute to 20 minutes, half an hour, an hour at times, right? So the result is that the graphs showing the hash rate are wildly inaccurate. You know, there's one that shows.

Starting point is 00:05:25 was a peak of 210 and a lower 90 X a hash during the week period, a few days ago. And if you know where to look, the real data is the highest it's ever been is 166, the 210 is wrong. And then the lowest it had been was, I think, like, about 126 X a hash during the week. And so people use the data from the graph, like they read the plot off the graph, but the error bars on the graph are enormous. So they said 40% drop, but actually it's more like 25 a peak. And Adam, that's because we're reverse engineering what we think that processing speed is based on how fast the miners are solving the guesses, right? So like if we go out there and we see that they mine a block in one minute and then they mine a block.

Starting point is 00:06:22 block in seven minutes, and then they mine to block in 15 minutes. It's somewhere in between that average, but that's only three blocks. So to really kind of know how much processing powers online is really, you need a lot of statistical data across a lot of blocks to really understand it. So I saw Nick Carter posted that he thinks that it was about a 25% drop in hash rate when that particular province in China went offline. Would you agree with that, or do you think it's even less or more. I think that's about right. But the difference is I said that on Sunday.

Starting point is 00:06:57 He said it after collecting a week to more data. So the reason I was able to see it more quickly is there's a kind of obscure site with a tiny little graph. So this site is showing you the reported pool shares pulled together from, you know, a dozen top pools. And the pool shares are happening, you know, every fraction of a second. So it's very high resolution. And so if you go onto that site, because the graph is so small, you know, you can probably

Starting point is 00:07:24 only see a pixel for every hour. But you've got a real-time graph, you know, if somebody, if that power station or if a smaller power station failed, you'd see it, you know, it would drop a bit of stuff. So it's, it's, you know, directly accurate view, which is how much hash rate is there right now by the hour. And the other stuff, you know, as Nick Carter said, you need to like wait a week to get enough samples to have a reasonably accurate measurement. And I think there's a CoinDest coin desk article, which got it about right, but I think they dug into how much power

Starting point is 00:08:00 went offline and inferred it that way. So this site with the real-time pull data is, is the way to go. What's the name of it, Adam? It's mining pool stats. stream slash bitcoin and at the top there's a little graph with a seven-day history and you can move the cursor around it. It tells you the exact hash rate. I don't know. It's probably hour or two period. It's funny. As an investor, I'm not worried about those dips in hash rate at all because I know, I follow it on a different website, but I follow it on my node. I follow it on other websites as well. And yeah, you have this cycle in there as well with the rain season in China and then the rain season ends. And every year there's a lot of thought about, oh, the hash rate goes down,

Starting point is 00:08:51 but it all boils down to the end of the rain season in China and all that. So it goes up and down. And the network just works as advertised with difficulty adjustment, just adjusting perfectly every two weeks to this new setting. And it doesn't worry me even a bit. Yeah. I mean, the other thing that I think some people were misunderstanding is they thought that this would be bad news for miners economically, that they would become less profitable immediately.

Starting point is 00:09:24 And actually, that's not the case, actually became slightly more profitable to mine. So they were sort of operating, like trading based on an inverted understanding of reality. And the reason that is is because it's true that the amount of coins across the whole network, there would be less blocks, therefore less coins per day. So less profit is going to miners. But for the people, the difficulty doesn't adjust during the two-week period. So if you are mining, you know, with an Xahash or a tera hash, some amount, your expected coins per day are the same. You're expending the same work and the difficulties are the same.

Starting point is 00:10:02 So, you know, you've got a lot of variance, but you're, you know, you're expected blocks mine per day is unchanged. And then as we saw the fees went up. Yeah, so the fees kind of kick in. So it got more a little bit more profitable because of the fees. And then as Pine Beaches said, you know, within about two weeks, the difficulty will actually drop. And then it will get even more profitable. I mean, the fees will probably normalize, but you will be expending less work per block. So you'll get more bitcoins per week as a month. minor and then presumably in the next period because they, at least in the coin desk article, they were saying that the miners affected, we're expecting that power station to be operational again within a couple of weeks. Then presumably the difficulty, we come back up again and we'll be back to where we were, you know, a little bit later. But it really was, you know, almost nothing. And actually, ironically, it's more profitable, you know, for us as miners, you know, our profit went up a little bit and we're expected to go up even more next week. And if there are

Starting point is 00:11:02 really people selling in the market because they think that we're making less profit. They're not understanding that difficulty doesn't change in real time, I guess is the point, right? Adam, would you think that I'm just looking at it? And whenever I talk to somebody who has a lot of mining experience, who's actually done it, they tend to look at this very differently than somebody who has never participated in the mining and they're just somebody who's looking at the price action and trying to trade it. Because you're, in my opinion, you're somebody who actually kind of fundamentally understands what's driving the price action. As long as we have more and more miners showing up and the hash power just keeps going higher, from a business standpoint, it just

Starting point is 00:11:42 tells you they're showing up and they're performing these actions because they're making money, right? They wouldn't be showing up and doing these things if there wasn't a profit incentive there for them to continue to do it. And so I'm assuming you see it the same way. What are some of the other things that you think that people miss that don't have that background or have that experience from a mining perspective of looking at the holistic picture of what's going on? There has been a pattern going into the halving where people will resurface the mining death spiral theory, which never happens. And I think there's a debate is the halving passed in, priced in, which is a fascinating debate. But at least the miners certainly know that the hash

Starting point is 00:12:26 rate is going to drop. And the number of coins they get per block is going to change. and that's going to push some miners out of profitability, and people are buying miners with a, maybe three-year planning horizon of how long they'll operate it before they'll upgrade it. So if they're buying a year or two before the harbing, they've factored that in, basically. And some miners are also not selling coins. So that's what we tend to do. And what we packaged into the blockstream mining note instrument as well, it holds the coins for the period it's pre-funded.

Starting point is 00:13:01 So talk to us about that period of time right before the having. People, you know, everyone had their opinion on whether it was priced in, whether it wasn't clearly, it was not in my opinion. And so the having happened. And then as a person who's running a mining operation, did you have to shut down rigs because of profitability at that point for, call it, because we had the having event in May, I think it was May 11th. So when we got into June and July, the price action for the most part was kind of going

Starting point is 00:13:31 sideways there as expected for the first, call it the first quarter, were you having to shut off rigs or were you still profitable even through that period of time to keep all of your rigs online? Yeah, we were profitable. What tends to happen is the least efficient operators will turn off. But I think the other thing that probably surprises people is there's a big kind of gap between you're going to make a decision to invest and buy more equipment and put it online now. that's, and in order to be incentivized to do that, you're going to want to see a certain period of projected return or a certain value of Bitcoin mine versus electrical cost in a ratio of that. And then if that gets to a good point, you'll do the investment.

Starting point is 00:14:16 But once you've made the investments at some cost, and there's another threshold, which is when would you switch this equipment off temporarily or permanently? And that level is far, far lower. So, you know, you might say, well, under these conditions, we wouldn't, if we would, if we We didn't have these miners, we wouldn't buy them right now. As you have them, and they're making more Bitcoins than the electrical cost, your cost of mine Bitcoin is at some discount to the current price of Bitcoin. You're obviously going to keep doing it to slowly recoup your original capital expense or

Starting point is 00:14:48 reduce your paper loss. And I think the other thing is that, and this is why it's, in my opinion, generally not a good idea to sell Bitcoins as you mine them to pay the electricity bill, that you will tend to mine more Bitcoins during a period like this where some people have turned off, you know, so you'll have a lower discount on the mine coins, but you'll continue to mine coins. And so I suppose it's kind of like, you know, buying in a bare market, you know, if you could dollar cost averaging, you get more coins. So it's a bit like that, right? So I think if you are, if you are selling coins to pay electricity bills when you're in that kind of

Starting point is 00:15:24 bare market for mining period, you're selling a bigger proportion of the coins for power. And so you want to, obviously, you want to, a Bitcoin is fungible at the end of the period, when you look at how many Bitcoins would we mine. So it's unfortunate to be selling a big ratio during periods. You want the ratio to be flat. And you can control that by setting aside the capital to pay the electricity bill before you start. So i.e., if you've got $100,000 to invest, don't buy $100,000 of miners and then be selling the coins each month. not to pay the electricity bill, but by $50,000 of miners and use the other $50,000 to pay the electricity bill. And I would argue you're actually going to make more money using that second

Starting point is 00:16:03 approach because you're going to be able to keep all of the coins and not be selling them, not be forced to sell them at disadvantageous prices in the volatile market. Lambie, I'm kind of curious if you have any thoughts or questions you want to throw in on this particular topic. Maybe about the blockstream mining note, because I think that's a very interesting concept, a very interesting structure. I've done a lot of structure finance in my 25 years' career, setting up SPVs, putting assets in there, and then selling the bonds on those assets. And the mining note, so the note is such a structure. Actually, you can make structures of everything that has a cash flow. And in a way, just disregarding how it's done actually, but

Starting point is 00:16:51 strategically, it's an important step because we have seen this trend of miners going from CPUs to GPUs to ASIC chips. Right now, one of the things that maybe restricts the further growth of miners is the funding of these professional data centers, right? It's a lot of money involved in those professional mining centers. And the way the nodes fund the mining operation is very clever. So you have to invest in the hardware. You have to invest in the electricity as well. If you package those cash flows and put them in a note that pays in Bitcoin, you have something that is very attractive for investors, but especially for Bitcoin investors that are already in Bitcoin. Like me, I will look at it like a Bitcoin investment. So the note is $200,000.

Starting point is 00:17:48 dollars, that would be like for Bitcoin right now, investment. And you get a return in Bitcoin as well. So you could see it as a physically settled derivatives contract as well. It's all Bitcoin. It's Bitcoin in, Bitcoin out. So it's Bitcoin price neutral in a way. And if you do some rough calculations, I didn't really do all the analysis. But if you do the rough calculations, you get a certain percentage of the network power. I think it's 0.0.0.1. one five percent, something in that neighborhood of the network. So you get around that percentage of the newly Bitcoin's as well. And it boils down to break even in about a year. And then you earn the second and the third year, you earn more, you earn your return. And it boils down

Starting point is 00:18:35 to doubling the amount of Bitcoin in those three years, maybe a little less, maybe a little more, hash rate, of course, being the uncertain factor. But from a volatility standpoint, when you're at those coupons that are accumulating. And I know the payout comes at the way at least Adam has his structure that comes at the end of the three years. That is a lot of stability in those coupon payments that you see sitting there in escrow. And you're not seeing the wild volatility with returns that, I mean, based on the returns that we're talking about is assuming that all of this continues into the future based

Starting point is 00:19:14 on what we expect to see. I mean, those returns are astronomical compared to anything else out there. I have a lot better than BlockFi. I mean, if you put four, four bitcoins in, you get eight plus or minus one bitcoins out in three years. And that's more than the 6% Bitcoin to Bitcoin. But I don't know that that's an apples to apples comparison because with this, you would have to sell the Bitcoin in order to procure or purchase the note, correct?

Starting point is 00:19:43 Like, it's not like you're able to avoid the tax. tax burden that's associated with your deposit through like a borrowing and lending platform? I don't know that, actually, if you can buy with Bitcoin as well. You see what I'm getting at, Adam, is we're comparing those two different ways to kind of employ your Bitcoin. One, you're kind of, you're depositing them and you're collecting interest on it, but you never have a tax burden for the sale. But how could something similarly be done through the procurement of the note so that you don't have a taxable event. Is something like that possible? I'm a kind of general tax planning question. I guess you might be able to use, get a secured

Starting point is 00:20:30 loan against Bitcoin, then you wouldn't have sold it and then pay off the loan or something like that. Yeah, that's true. You could do it that way. So you'd borrow against it and then with the money that you borrowed, you could procure the note. And you know what would be really interesting. I'd be curious to know if the return that you would expect to get out of that over a three-year period of time based on the interest that you'd be paying against, whether that would marry up against the risk-free trade that we're seeing in the spot contango trade. You'd have to run the numbers. On average, yes. Of course, everything is volatile in the Bitcoin space. Now, I'd say that the note is generally lower volatility, like it has a lower ZD score, because you have some kind of discounted dollar cost averaging behavior and some derivative

Starting point is 00:21:18 behavior just due to delivery of new equipment. If the price goes up too fast, that takes a while to backfill the equipment. And that's the current state of the market. You know, shortage of miners higher price than a surge price compared to normal. difficult to get new miners. So therefore, higher profitability per jewel, you know, per kilowatt hour in. But so I think the average over the period is it reduces the volatility as compared to buying. And it still has a pretty good upside participation, like about 60% upside participation average. We did sort of backtested periods across every 36 month

Starting point is 00:21:55 period for, you know, some years going back towards the early ACEX. And so that's saying, that, and as Bitcoin has generally gone up during that period, I would say that, you know, it has historically achieved a return that would exceed typical borrowing costs. And there are reasonably low-cost ways to borrow against Bitcoin. If you, for example, put Bitcoin in some kind of ETF products in Europe, you might be able to borrow against that because it's then a financial instrument. And actually, the BN is a financial instrument, too. I mean, it's a European securitization vehicle. I think it's the first one. office that's both a token, like an STO, liquid security token, and a European security, so

Starting point is 00:22:39 it has an ICIN. If you have a bespoke brokerage, they could probably take deposit of it because it has an Icing and maybe use it as collateral as well. So that'd be interesting. If you could put the value of the notes up as collateral, then it's a little bit like you borrowed money and then you put the asset that you bought with the money back into the collateral pool. this kind of thing is possible with a more sophisticated brokerage account.

Starting point is 00:23:04 It's a kind of one level of recursion, basically, right? That you've put, unless you're doing it with bonds, you would have 100,000 euros, buy some bonds, and then put the bonds back into the collateral, and now you've got a lower risk, or you could borrow against it, again, that kind of thing. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo

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Starting point is 00:27:15 Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Hey, so Plan B, I want to go back to just kind of how we open the conversation as far as this correction that we're currently seeing. Because before we started recording, you and I were chatting just briefly about similarities to drawdowns that we saw in the previous bull run, the 2017 bull run. And just for a little bit of context for people, so during the 2017 run, we had, we had the

Starting point is 00:27:58 price action correct six times in excess of 29%. For this current bull market that we're in, we've only seen the price correct, 31% and then this one right now is at 26%. So far different from the number of corrections that we've seen. One of the things that you brought up when we were, you know, just briefly talking about the current situation was the RSI. Talk to people, I know this is a really kind of generic metric, but talk to people what this metric is and then kind of how you're using it right now just to kind of look at the market. Yeah, so it is technical analysis. It's an indicator like a moving average is an indicator or bowling or bands. So the RSI, the relative strength index, it tells you if a series is trending up or trending down.

Starting point is 00:28:49 And it is a number between zero and 100. So everything above 50 is trending up and everything below 50 is trending down. And, well, as with all TA, right, all technical analysis, it's not meant as a predictive thing. It's meant as a measure that gives you some situational awareness that you can look it up in the past, similar situations, et cetera. It's kind of a language. But, well, everything, if you look at Bitcoin, the RSI is very interesting. because normally an RSI of a stock or currency or, for example, would be between 30 and 70. So if the RSI is above 70, they say it's overbought.

Starting point is 00:29:29 And that would be a time where the trend could reverse into bear. And if the RSI is below 30, that would be the moment that you buy where it's oversaw. But with Bitcoin, those bandwidths are slightly different. And it depends on what time frequency you look, if it's day. weekly, monthly, RSI. But one thing I particularly follow is the weekly RSI. Don't ask me why, but it shows a very distinct pattern if you look at last 10 years. And indeed, we have been above 70 for almost five months. And that's kind of unique, different than 2017 and 2013. So I was kind of wondering myself, are we going to see an RSI of 60?

Starting point is 00:30:20 So will it go down anytime soon? Because that's what happened during the bull market in 2017 and even in 2013. And well, speaking of the devil, that's exactly what we're seeing right now. So the RSI, the weekly Bitcoin is a little bit below 60, 59 or something. And yeah, if history is any indication, we look up 2016, we might go a little deeper, but this would be around the levels that you normally go up again. And it just the pattern and the difference with 2017 is remarkable to me. Do you find that there's some resistance layer?

Starting point is 00:31:04 I've heard a lot of people online talking about a resistance layer kind of around 47,000. Do you buy that or do you see? any merit in even discussing that? No, actually, I'm not much of a TA guy. I spent some time on a training floor. There we talk about TA indicators all the time. And even in the institutions, in the dealing rooms, we follow the indicators, but I don't know, resistance lines, etc.

Starting point is 00:31:33 What I do find more interesting is the on-chain analytics that also show you where. It's actually data from the flows, right? The selling and the buying or which coins are sold and et cetera, et cetera. So I give them more weight in my decisions than the TA. The TA is just, well, not for fun, but anecdotally. So what are you seeing right now in that type of analysis, the on-chain data? On-chain, it's very clear that a lot of the old coins are being sold, right? and that a lot of the action is still to come.

Starting point is 00:32:13 So if we compare flows, coins, and how they flowed in 2017 and 2013 to today, there are several measures actually, but they all point towards that we're halfway into this boom market, have a long way to go, like really 50% or something, and the other half still to come. So that's a very bullish and optimistic view, of course, but I think it's a deniable there.

Starting point is 00:32:42 And Glass Note, other people are tweeting about it. I'm looking at that as well. Well, there's one measure I follow, but it's proprietary, so I can't say much about it. But I'm very optimistic, but based on the on-chain stuff. And, of course, it's very convenient that it aligns with the stock-to-flow stuff. That also says we have some way to go, yeah.

Starting point is 00:33:04 Adam, I'm going to throw it over to you. Do you have any comments or questions on this one? I mean, I think the interesting, one of the interesting things is, I think this is a glass node data, but other people are playing the same, which is that the removal of coins from exchange. So it seems like large buyers are buying chunks of coins in any pullbacks and cold storing them, basically. And so it seems like in terms of the comments we just had about not as many deep pulls back pullbacks as in previous cycles and not as deep that these kind of buying activities are probably making it more buoyant or recover more quickly. So see less deep pullbacks because there's an enormous amount of leverage trading and liquidation cascades, which are part of the market. The other thing I like is this graph I'll just send it to you, which is somebody put together a graph of the price during the previous two for halving periods and then drew a kind of average from the middle of it. So, anyway, it shows us being about in the middle.

Starting point is 00:34:19 So we're about halfway between the price increase this far into post-halving periods. We're sort of right in the middle of having been higher in one of those previous periods and lower in the other period. So we're sort of tracking in the middle of it to the extent that you could infer anything from that. So I think that's kind of interesting. I like to try as well. I mean, I just tend to look at it that, you know, in terms of people looking at the current market,

Starting point is 00:34:47 I mean, I'm not remotely phased, just, you know, buying some more and evening out the volatility. So people say, hey, Adam, how comes you're not all in? Where are you getting the money to buy coins from? Well, I have a dollar allocation and I'm just profiting from people's lack of confidence, lack of conviction. So, you know, if they panic sells them, I'll buy them. And then when it's, you know, maybe when it's back to around where it was before us, I'll sell what I bought and keep the profit in Bitcoin and do it again. So I think if enough people do that, it provides a bit of price support as kind of distributed

Starting point is 00:35:26 market making or something. And of course, there's kind of mutual reflexivity, right, that different people having confidence for varied reasons kind of support each other, right? So I'm going to be more confident because I have the impression that institutional buyers and high net worth of individual individuals are taking opportunities of temporary pullbacks and buying, taking them off exchange. So, you know, then I'll buy it going down, assume that they will too. And so it's kind of a neutral cycle rate of people trading for a variety of compatible reasons.

Starting point is 00:35:57 Yeah, I think that's one of the big differences, right, between this cycle and the last cycles, that the institutions are now stepping in. Big buyers are there. You can see it in the price patterns. Once it goes down, it immediately gets sucked up by big buyers and they move it from the exchanges. So that's one thing that changed. On the other hand, the thing that doesn't change, of course, is human nature, right? People phomo in, even the institutional buyers sometimes, because those are people as well.

Starting point is 00:36:24 And then at a certain point, they'll get the fear sets in, right, and they sell. So there's volatility, if you will, the ups and downs, the bull markets and bear markets. I don't know if that will ever change. And of course, that's the underlying thing in a big debate at the moment between the super cycle or not. So are we going to have another bear market after the old time high, maybe later this year or early next year? After that, will it be a bear market? Or are things that different this time with institutional buyers that we will not have a bear market and a cycle anymore and go up, up? Like, well, Michael Sater likes to say, and I think Preston, you are a super cycle man as well.

Starting point is 00:37:09 So that's the big question. I don't have the answer, but it's certainly different. And I also know why, well, people that are in tech investing and earned a lot of money with investments in Google and Amazon think that way. Because if you look at the tech stocks, it's always volatile in the beginning when there's a lot of risk about the technology, about the regulation. And then once all that is settled, then it goes up, up, up. And the volatility is gone? So, yeah, is Bitcoin a new technology? and does it behave or will it behave like a technology stock like Google and Amazon?

Starting point is 00:37:48 Or is this a thing that will be influenced by greed and fear for at least the next 100 years? And I'm of that latter group, but there's a whole debate that we could have about this super cycle. We're a person who would support the super cycle, and I'm just going to be completely agnostic to the conversation because do I think it could happen? Absolutely. Do I think that this could keep playing out for more years into the future? Of course. But if for people that would be making the super cycle argument, they're going to immediately go into a lot of this derivatives conversation that Adam and I were talking about last week, that you clearly have highlighted probably earlier than anybody else, Plan B. Then you start looking at the stuff that Adam's doing with his note where you're, I mean, if you buy one of these notes,

Starting point is 00:38:37 Adam's escrowing all the Bitcoin he mines for the next three years before he pays it out. So that's effectively a lockup of Bitcoin. It almost seems like a lot of the products and the financialization of Bitcoin that's currently taking place involves an incentive structure that involves more locking up of coins and taking and clawing them off the market to be put to some form or some type of use that involves over collateralization. So does that mean? that we're getting almost like a second-having event through all of this? Is that the reason why maybe this cycle right now is playing out a little faster as far as the price action is concerned than the cycle we saw in the past or the previous four-year cycle? I don't know. It kind of seems like that would support the narrative, but I'm opening it up to you guys to hear your thoughts. I wouldn't say it's another halving because those aren't. of existing coins that are locked up, like gold could be locked up in vaults, but I know what you mean. If the coins are off the market, if there's no sellers, then yeah, well,

Starting point is 00:39:49 that will have a price impact. And yes, I think those things, like miners funding their operations in a way that they don't have to sell is huge. It's a huge impact on the market. And also the derivatives markets are a huge impact on the market. But there's more, of course. I used to say, forget about adoption. It's all about arbitrage. And that plans into this as well, because the contango premium that we see on the futures markets right now. And that's one of the reasons, of course, that people go do this cash and carry trade. They buy the Bitcoin and sell it in the future, thereby locking up the collateral, the coins they bought for a year or half a year or whatever, that goes away when that premium goes away.

Starting point is 00:40:41 So before the big liquidation last weekend of all the leverage longs, we saw the Contango premium, the basis premium, be 40%. And now it's like 30, maybe it's 25 at the moment. And it used to be 10 to 20%. And in the beginning, like in 2018, even parts of 2019, it was in backwardation even. So the future price was lower than the spot price. How will those coins be locked up and for how long? That would be the question.

Starting point is 00:41:13 But I would certainly see that as long as the contango premium is there, and especially as large as it is right now, there is more room to go up. Because what it essentially means is that there is two parties finding a natural equilibrium in risk return terms. On the one hand, it's the leverage long. that use futures to leverage and to have a position that has 10x the Bitcoin returns up and down. And against that group of leverage longs, there's the cash and carry people,

Starting point is 00:41:49 more maybe the institutionalized buyers that buy the Bitcoin and sell while they have the collateral at hand. And they take a lesser return, but with much lesser risk. So it's all a risk return game. The leverage longs take much more risk than Bitcoin and hope to get much more return. And the cash and carry traders are taking less return with almost zero risk. And those groups find each other. So it's a very natural equilibrium. And as long as those groups are there, as long as there's leverage long as there's

Starting point is 00:42:26 institutional, traditional buyers that are happy to take the 20, 30, 40%, well, Bitcoin neutral return, this is a, this accelerates the bull market at the Bitcoin price, in my opinion. And by the way, the leverage longs are not the only buyers in that corner of the world. Those are also the traditional investors that don't want to hustle with keys and stuff and want an ICIN code on the future so that they can administer it in their systems. So it could be, so those are also, I know that funds, trackers, track the Bitcoin price, but do not want to buy the Bitcoin outright and hassle with custodian or keys themselves. So they just buy the derivative and replicate the Bitcoin

Starting point is 00:43:17 exposure with it. So that's also a large group. And it doesn't go away. So in a way, it's a long, long way of saying, I might agree with you that especially the derivatives markets and the funding of miners in the novel way that Adam is talking. talking about could enhance this cycle and make it maybe into a super cycle. I'm fascinated by the fact that there's some kind of positive feedback loop between these different activities. So I would say also though as well as the sort of degenerate traders, you know, the 10 times people who are often taking very short time positions, you know, minutes, hours, days, but not very long. They're also kind of longer term holders or people who will take a much lower leverage,

Starting point is 00:44:08 like 50% leverage or two times leverage. So the liquidation level is maybe $25,000, $30,000. They feel comfortable with that. They put an allocation in. They end up paying a rate, but in a bull market, that can pay off for them. So I wouldn't encourage people to do it because if it makes you nervous, then you're going to make bad decisions and it has risk if you don't manage it properly. But there are people that will do that who are more long term.

Starting point is 00:44:35 They'll hold that position. I mean, people have been holding those positions since December, right? For example. Obviously, they're giving away a fairly high premium to people that are lending the dollars in effect, but they're on a winning side of that balance of profit at the moment until it changes. So I think the other thing that's interesting is the feedback loop because as Plan B said, the fact that people are having to lock up Bitcoins to do this cash and carry trade, so they're going to buy a physical Bitcoin and sell the future, they are having to hold

Starting point is 00:45:11 Bitcoin and they are potentially completely Bitcoin neutral. So we'll bring in people who are not yet in a Bitcoin ecosystem, don't have a, you know, and convicted by a Bitcoin, but this is a way to earn an attractive return. and they're providing liquidity to people that want to either short-term trade or, you know, hold a long position, a lower leverage long position for three or six months or something like that. So it's just providing liquidity to them. And the combined things are both positive for price. And so if the price is going up, because one worry is like, what's the feedback loop?

Starting point is 00:45:47 You know, eventually, well, worry, but, you know, if you're collecting yield, this would be a worry, is that eventually more players bring, you know, they're currently collecting one, two percent or zero or negative, depending on term, in the regular markets, and they will come into the system and there'll be so much liquidity that the premium will drop a lot. But I think the thing that makes it potentially sort of perpetuating is that because both of those factors, locking up bitcoins and people buying, taking bitcoins of exchanges are pushing up the price, that I mean, at a higher price, the Bitcoin ecosystem goes from a $1 trillion market cap to a $2 trillion. It can absorb more money because somebody who is 50% long or two times long is going to tie up more capital doing that.

Starting point is 00:46:34 They still have to say a number of coins they're doing it with. And so that can absorb more U.S. dollars and euros. And then it just keeps going and absorbs more and more money. So I'm interested to see how long it lasts. Of course, these rates are basically calculated typically every eight hours. Well, it depends on the type of platform. I think the CME thing is you're buying a future so you know the price, you know, the premium, and it's like a three month or whatever the term is.

Starting point is 00:47:00 So you've got your trade locked in and just wait for maturity. But some of the crypto exchange leverage platforms are calculating perpetual future funding rates and charging them every eight hours, paying them out every day. It varies a bit per platform. and those rates are highly variable and can get silly at times, you know, in a very short period where there's a rapid price movement, basically all the liquidity on the platform will get used up right down to kind of, you know, half a percent a day kind of rates or a crazy rate, not sustainable, but it averages out, so it will be lower.

Starting point is 00:47:38 If I may add two things, that argument, Adam, that you made about attracting more liquidity, That's very true, because if I look at the traditional investors, they might be scared a little bit about Bitcoin with its minus 80% drops once in a while, but they really have recognized the cash and carry trade because they're familiar with it in other commodities and foreign exchange markets. So in the company that I used to work, this was the number one argument for them to look at the Bitcoin market. So they recognized the futures basis of 20, 30, sometimes 40%, and thought that was of course, much better than they're used to, and that triggers them much more than the outright Bitcoin position. And the second thing is, let me be very clear about derivatives markets. Through the eyes of a traditional investor, that's a very good thing. That's also a thing,

Starting point is 00:48:32 a mechanism to attract more liquidity. It attracts buyers that want to have Bitcoin exposure but with less volatility, like the cash and carry traders. And it attracts people that want to have more, even more risk and return, like the leverage longs. And thereby both groups, as long as both groups provide liquidity like they did last year, that's a very good thing for Bitcoin, I would say, and it makes the market so much more mature. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:52:24 advertisement. All right, back to the show. So when we're looking at this trade where we're seeing the largest spreads, it appears that it exists on exchanges that allow, that are immediately settled, that have all the aspects of tokenized fiat currency to it. So I'm talking like Bitmex. They allow 75x leverage or whatever, right? Those are the exchanges where you're seeing these spreads be the largest. What I find interesting is you don't have any of that happening in the United States right now. This is all outside of the United States that these exchanges exist that allow these types of activities. And it hasn't been approved here yet for Adam was talking about perps and how this is a new type of derivative that hasn't existed anywhere else because now that

Starting point is 00:53:16 you have immediately settling security tokens, or I shouldn't call them security token, And now that you have immediately settling tokens, you now have this capability to enter these perpetuity-type derivative products. So I find that, and I'm asking this more than stating this to you guys, are these products that once they make their way into the U.S., which I suspect they will here probably in the coming year or two, when they arrive here, is this only going to further extensuate what we're seeing with this cash and carry trade because now you're going to see it actually arrive in the U.S. because CME doesn't work this way. The U.S. derivatives markets don't work this way.

Starting point is 00:54:00 They don't allow people to go 50x leverage on whatever position they think the direction of the market's going to go. And if they're wrong, you know, five minutes later, well, then they're liquidated without the counterparty risk that you see in traditional derivatives markets. So I'm kind of curious to hear your thoughts. If that's a true statement, everything that I just stated, and it's it arrives in the U.S., does that market size that now is also participating in this activity enhance things or kind of amplify what we're already seeing? Yeah, I think it will make, it is true what you said, the CME has lower spreads because it's not Bitcoin physically settled, and it doesn't have the leverage that a bitmax or a

Starting point is 00:54:42 dairy bid or all the other exchanges, Binance, for example, give. That's very, very fascinating to me as well. So there seems to be a very direct link between leverage and spreads on the cash and carry trade. So I know that U.S. people cannot access those cash and carry trades in physical settled exchanges, which is very weird to me, but they're not allowed. They're blocked, right? If U.S. citizens cannot trade on Bitmax, I think. No, we can't.

Starting point is 00:55:10 We cannot do this stuff. I'm curious if Adam knows kind of the impetus of why. I mean, I guess the US is a more complicated, on a personal basis, I'm looking at it from a European point of views. I have the same outlook as Plan B. But, and Blockstream is a Canadian parent company. But we do have subsidiary in the US. So it is something that you see that basically, I think the exchanges defensively would sooner or not have jurisdictions that have a complicated financial regulatory. And they don't want to trip over the fine print of some rules. And so the defensive thing is to just say, it was somewhere, I mean, there are some which are US, but not New York, because New York introduced the bit license, which was more unrest than the general US rules. I think rates are higher as well on venues that let you use Bitcoin as collateral.

Starting point is 00:56:12 And I think that may be what's complicating the CME situation. because, you know, I think you have to put up quite a lot of collateral, maybe 50%, if I recall. And that collateral can't be the Bitcoin that you bought to do the cash and carry because they don't have a way to deposit Bitcoin on there. So you need to use some other collateral. Let's say you've got a share portfolio and you can access CME through, I don't know, let's say interactive brokers. I'm not sure if they have it.

Starting point is 00:56:38 But let's say you have that and you have some stocks. You can use them or cash presumably as a collateral, but that's going to limit what you can do. Because the Bitcoin that is actually collateralizing the trade is off balance sheet, right? It's unrecognized. So that limits the access to that cash and carry trade, where the other platforms have effectively cheaper leverage, you know, and you can deposit the collateral into the platform itself. So, of course, they can safely do it. I mean, I think what CME is doing is they, you know, they will liquidate you if you go too

Starting point is 00:57:15 close to that 50% line, but the other platforms can let you get, you know, within half a percent of a line because as long as they can liquidate in time, it's, you know, it doesn't impact the exchange. And of course, people doing these very high leverage things are, I mean, they're taking a risk and typically they are putting stock losses really close above and below, right? So particularly below, so if they are over 20x long, then they probably got a stop not far below it. Or they put a small position size on that will liquidate in isolation. So it's, you know, at 20 times there's an implied 5% drop liquidation minus like a bit of wiggle room because there's a buffer between, you know, there's another half percent on top. So something in that order.

Starting point is 00:58:05 So maybe 19 and a half percent. The demand is coming from, I mean, some of the demand is coming from people that want to buy Bitcoin. and have mostly Bitcoin. But obviously it's risky and I wouldn't necessarily recommend it. And I don't think that that's necessarily my point is people doing this trade. I'm looking at it more from a mechanical standpoint of because this trade exists and because the safety like you're describing Adam is there because you can immediately settle. I mean, one could maybe even try to make the argument that it's safer than the CME because of

Starting point is 00:58:40 the time and the collateral that's being used, the time to settle and the collateral that's being used and all that kind of stuff is actually riskier than some of these exchanges that allow this insane amount of leverage that we've never seen before. My point is more on, I think this is why you're seeing the spreads that you're seeing between the spot and the future price is because of some of these exchanges that have this built into just how they systematically work, that you're seeing these spreads develop. I'm just interested that if and when, because I suspect it's going to happen in the United States, it's a regulatory constraint at the moment that maybe it just adds more fuel to this, to this fire that's burning, that locks up more coins, that incentivizes the

Starting point is 00:59:31 locking up of more coins through the derivatives market. Yeah, I think the regulatory restriction, I wouldn't surprise me if there would be regulatory arbitrage in the future as well. These restrictions and these kinds of costs, what normally causes the contango spreads, right? In gold as well, there's a 1% contango spread because you have to insure the gold, you have to storage the gold. But I guess the fact that US citizens cannot do this trade will be arbitrage by setting up a fund that has this as a investment strategy

Starting point is 01:00:04 and then selling the fund or setting up a note or maybe sending up a coin. I don't know how easy that would be on liquid or something. But yeah, I think if you have a coin that pays off the cash and carry, that could be very interesting. And maybe something that is legal to buy in the US. And it will for sure open the floodgates. And for sure, this whole derivatives, cash and carry and also the cover call writing

Starting point is 01:00:30 in the option department is a very important network effect in making Bitcoin a, well, eventually a hundred trillion dollar asset. Well, and you just think about how volatility only incentivizes this activity more. And so before we started recording plan B, you and I were talking about where the price was at in the previous 2017 cycle about a year after the halving event and then how much more it had the run from there. If we just assume that we're going to see a similar activity playing out in the next 180 days from where we're at right now, that implies a lot more volatility in the price action, which for me,

Starting point is 01:01:13 when I'm looking at how is that going to interact with the derivatives market, especially these ones that offer tons of leverage. To me, it seems like those spreads are going to continue to widen with each expansion and the price growth. And it's just going to attract more and more people that are trying to capture that spread. So I'm assuming you see it the same way. Do you see differently? Absolutely. It will go up and down and the spread. I don't know how high it will go. I think 40% that we saw last week was quite high. Aggressive. Very aggressive. I have never seen that before in my life. But even at 20 and 30, if you compare it to the normal returns that an institutional investor like a bank or an insurance company makes or even a pension fund, that's wild.

Starting point is 01:02:01 It's insane. Especially if you compare it to the risk, there is so little risk, maybe some credit risk on the exchange and stuff. But yeah, so it will attract, and I've seen that with my very eyes, it will attract traditional investors. By the way, I am doing this trade. I'm in Europe, not restricted by any US laws. I'm doing the cover call writing. I'm doing the future sketch and carry for months now. And a lot of my friends do. There's maybe every week somebody that starts to do this on a personal level. And those are all professional investors that take these thoughts and these little personal experience to their asset liability meetings and they talk about it. I know they talk about it because I was there, right? This is something that will happen and it cannot be ignored.

Starting point is 01:02:47 If you're looking at 4% return with a lot of risk and then there comes a guy that says, well, you can make 20 or 30% without any risk. No, no, no. Well, it's a very interesting thing and I'll be watching the spreads like a hawk because that tells me something about the future. Do you think it's like the free market interest rate? You know, because people have been talking about real asset price inflation with all the money printing. And the market rates are set by monetary, you know, targeted by monetary policy commissions that are setting, you know, the prime rate or the base rate is more free market, right? Because it's just people pay what they want to pay. And I'm just curious because people have looked at different metrics.

Starting point is 01:03:33 like M2 money supply inflation, how much of the US dollars in existence were printed in the last 12 months, and actually even the headline consumer price indexes are under control. People are just empirically, I think Michael Saylor posted rates of prices on 20 top commodities, lumber and different things, and they're all up, you know, double-digit percentages. So maybe people who are putting assets to work at 2% are actually losing 10 or 15% and the people getting 20 to 30% on these yield strategies are making a real return above the actual inflation rate. Because you never know the actual inflation rate until the dust is settled afterwards,

Starting point is 01:04:20 really. Yeah. And I completely agree with you, Adam. I think that the more I'm looking at this and the more that I'm saying, okay, what is the inflation rate? rate? What is the interest rate that should be constructed on top of said interest or inflation rate? All roads lead me to this market and this particular trade that we're talking about, representing that most accurately, at least for me. And I obviously have a bias towards Bitcoin,

Starting point is 01:04:45 but I definitely don't see it at one and a half percent on the 10-year treasury. That's for dang sure. Right. Some sort of other thing you can look at for, you know, market direction engage people's future expectations is the option market. So, for example, Ledger X, I just pulled it up. And, you know, they introduced a $200,000 call option for the end of this year a little bit ago. It used to top out at $100,000. But since the price of Bitcoin is up, they've put $200,000 and there looks to be quite a lot of open interest for a $200,000 call option end of year with bid-ask spread between 3,200 and 4,000. I think a big part of that spread is actually the commission structure on the exchange. It's like a 15% or something. But, you know, it's basically

Starting point is 01:05:33 saying that if you have Bitcoin and you sort of conceptually be willing to sell at 200,000 at the end of this year, you can collect $4,000 now. And it's kind of like writing a limit order and putting on the exchange and not being able to cancel it, right? And somebody's going to pay you for that. So you get the $4,000 now. If Bitcoin never reaches $200,000 this year, you keep the $4,000. If it reaches $200,000, you're forced to sell it and pay the upside above $200,000 to the person who bought the call option, but you've still got the $200,000. So, you know, I do know people who have been selling these, but when I was looking at them and comparing it to Bitcoin and Bitcoin yield strategies, I started to think it's mispriced.

Starting point is 01:06:19 because, and that you should possibly be buying them, which is a curious phenomenon, just because, you know, the, if the cost of the call option, you know, so let's say it's going to cost you $4,000 to buy it. And that's less, you know, that as a percentage of the current Bitcoin price, when Bitcoin is $60,000 or something, it's, you know, 6 or something percent. And if you can achieve that return on Bitcoin, Bitcoin yield, then interest is, you know, is. is better. You know, you've still got the coins at the end, right? So that means this option is cheap and you should buy it. And so if that's correct, but that arguably is saying that, you know, 200,000 end of year is what the market's saying. We don't know what's going to happen, obviously,

Starting point is 01:07:07 but the way the market's pricing it, you could argue that's underpriced. So anyway, it's interesting. And of course, then they've got the 400,000 at the end of December 2020, to priced spread between 4,400, bids and 6,000 ask. So it's not that much more expensive, but it's a loftier target. Yeah, that's for sure. Those are very interesting games you can play.

Starting point is 01:07:33 And we're only discovering them, right? It's for Bitcoin, the whole, the fact that those options have implied volatility of around 100% is crazy. How do you price that? And of course, a part of the option price is the future price. So all the basis contango spread, if you will, that we talked about is in there as well. There can be very nice arbitrage between the future market and the option market as well.

Starting point is 01:08:02 And it all leads to more liquidity, more people buying. Yeah. And I can tell you a little bit, like, if you're an institution investor and you have to invest big some like a billion or $2 billion, $3 billion, whatever, in asset, you want derivatives markets there. You want future markets, you want option markets, because those are exits. So even if the spot market is closed, which can happen or gives you crazy prices, you have some other ways of getting out of your trade. You can short it, you can buy put options.

Starting point is 01:08:39 And the fact that you can get out more easy is also a big part of the decision to get in, to invest in Bitcoin. So yeah, I hope those option markets will grow as the future markets because they're relatively small right now. I think the PRP contracts that obviously we don't have here in the United States also offers a really interesting solution for people that don't want to have to pay. If you want to get into a, let's say you want to buy a put because you think the price is screaming high and we're going to go through another cycle or whatever, it gives you kind of a unique way to not have a huge upfront cost, but you can still participate in that protection, quote unquote protection if you think that it's going lower. So I'm interested to see

Starting point is 01:09:23 some of these newer derivative type things showing up here in the United States. I really hope it comes in the coming year or two because I think that it's going to only add to the free and open market. And at the end of the day, I think we talk about all these really kind of complex trading strategies. And I think for most people, they are absolutely the wrong thing for them to even think about getting involved in based on maybe what they know or what they think they know. But I'm looking at it more from, and I want to be really clear about this, I'm looking at all of these conversations that we just had as a mechanism to understand why Bitcoin is so important moving forward and how everything that's being engineered around it is supporting this idea.

Starting point is 01:10:11 of a real free and open market for the cost of capital and for conducting economic calculation for the value of everything on the planet. That's why I think everything that we just talked about for the last half hour or 45 minutes or whatever is so important. Because I think it's all the things that kind of support that to materialize out of all of the insanity that we've seen for the last from the 2008-2009 crisis. Absolutely, President. I couldn't agree more because in the U.S., it's not half as bad as in Europe, right, with the negative interest rates. And wait till that comes to the U.S. It's, it is this whole context of a crazy world with trillions and trillions of dollars in QE and negative interest rates that sets this whole thing on its head. And it's as if there's two worlds right now, a traditional world. with QE and negative interest rates and, well, zero interest on your money.

Starting point is 01:11:15 You cannot use, talking about usability, you cannot use money anymore. Money on your bank account is a liability in the Netherlands and in lots of, in Germany as well. It's a liability. So there's one world with that, and there's another world where you can make 40% interest rates. 40% interest rates. And it's the same time. It's like a quantum world where, or you can. you have those two things at the same times.

Starting point is 01:11:41 And well, there must be a moment, and we can see that happening, of course, that the people in those two worlds are talking. But it's Kafkaesque. It's weird. It's sort of, it's amazing to live in those two worlds at the same time. And it's even more amazing to see people that don't get or see the other world, which there's a lot. Yeah, yeah, yeah.

Starting point is 01:12:08 I know. And are we so smart or are they so dumb? I don't know. Maybe we're going to find out. I think people would also look at high yields and ask it, is that too good to be true question? Like what's going on for that to be the case? And my one thing that would deter them is exchange custody risk because a lot of the exchanges are effectively startups.

Starting point is 01:12:35 What's their solvency like? will they become insolvent due to a mess up or a rapid price movement, which can happen with derivatives, right? You know, something like they're all side bets and they have an insurance fund. You know, sometimes the price moves too quickly for them to calculate things properly and do you have to socialize it? So they got a fund, the insurance fund that takes it first. So there is platform risking some of these things.

Starting point is 01:13:01 And their startups, they're immature platforms. So they're not necessarily the same grade as. you know, the New York Stock Exchange or CME or something like that that has a lot of rock solid trading platforms. And certainly some of the exchanges are infamously crash underlined, which is, you know, very annoying. That's a reason to switch exchanges, I would say. If you can't trade when you, when it's a key point, you know, what's the point of trading on that platform? Because it could burn you at the one time you want to trade. So another question for some people asked, you know, talking about custody risk is what do the three of us think about Bitcoin

Starting point is 01:13:42 interest products? And I think that they typically involve custody risk. And to generate a Bitcoin yield, I mean, if you look on platforms that have sort of trading a margin lending market for traders to users collateral like BitFenex, the lending rates on Bitcoin are extremely low, like below half a percent. And so when people are, you know, there are a number of companies that are offering five and higher percent points on Bitcoin, maybe with teaser rates. But, you know, there are people offering relatively high rates on Bitcoin. And certainly for people who are, you know, most of their portfolio or net worth is in Bitcoin, then getting any kind of interest rate on Bitcoin is attractive to them. So I think really what's going on, though, is behind all

Starting point is 01:14:30 these products that are generating interest, they have to do unsecured lending or nobody's going to borrow off them. And who are they lending to? You know, if you listen to their pitches and there are a number of podcasts out there where they've explained approximately how they do it, they are trying to manage the risk by diversifying. In some cases, they claim to stand between so that they will absorb the first loss. If they've got, you know, 20 different people that are lending to and one of them becomes insolvent, they'll cover that until they can't. And of course, they try to analyze, like, know who they're lending to. Is the credit rating good?

Starting point is 01:15:05 Maybe they don't have a credit rating. Ask around, there's a word on the street that these guys have got experienced traders and they're trustworthy. But, you know, of course, it's, you know, the diversification is better than not diversification and standing between is good until the, you know, the lending platform becomes insolvent. So I tend to not do that or to be careful about doing that or to do that with a smaller allocation, but I know there are people who are looking at the interest rates. Of course, there's a bit of a race to the bottom phenomena where you can achieve, as a lending platform like

Starting point is 01:15:40 this, you can achieve a higher rate behind it by being more aggressive lending to people with lower sort of credit risk, I mean, worst credit risk. And so then you offer a higher rate and attract the users. So if they're sitting there kind of one-uping each other, the actual risk is creeping up. And we might eventually see a amount of got. like incident where one of the lending platforms becomes insolvent because the hedge funds being probably small startups themselves, right, that are pro-trading shops effectively gets too aggressive with their strategies. Of course, there are perfectly valid ways for these funds to create a yield. For example, trading short-term options, for example, right? And if they have a 24 by 7 trading shop

Starting point is 01:16:28 and I've got experienced traders, they can probably make, you know, a yield above what they can borrow a Bitcoin for. But everything has risk. Adam, I think what you're saying here is you're calling out borrowing and lending platforms and telling them that the same thing that they're holding their retail investors to as far as over collateralization, they also need to hold their institutional depositors and borrowers to the same standard. Is that kind of the message? Well, I mean, I'm supposing they won't have visibility into that because they'll be lending to a fund. And the fund will, you know, maybe to get an idea of the risk profile before they lend to the fund, they'll ask them, you know, if they track record of their traders and they'll say, you know, this person was on the trading desk here or something like that. And approximately what the strategy is. Now, they may not want to describe their strategy because it's proprietary information, right? But so that may be, you know, somewhat uncontrolled but diversified risk. But there are. are, you know, there are other lending platforms. And this kind of risk applies to some of the

Starting point is 01:17:32 ways to generate your dollar return too, which is, you know, if you are provided margin lending, you're exposed to a platform risk. If you are using the long, short strategy, which is a variant of the future by spot sell future. So it's a variant of that. You, you know, if that platform has an impairment, your funds could be at risk, even though you're not Bitcoin exposed, your dollar exposed to the platform, right? And so there are other ways to kind of reduce that risk and maybe give up some of the, reduce the default risk and give up potentially a little bit of the interest rate upside.

Starting point is 01:18:08 And the main one I see for that is hoddle, which is a way to lend dollars and it uses Bitcoin as collateral, but in a direct way. So as the lender, the coins are held in a multi- SIG and you have one of the keys, and you can see that the collateral is not moving, basically. And so there's no unsecured relending behind it.

Starting point is 01:18:34 You're getting a matched interest rate that's coming from the borrower. And my impression is probably a lot of these borrowers are actually using it as margin to trade or turning around and collecting a slightly higher yield on the kind of strategies we were just talking about. So if you're interested in the yield, but you're worried about the platform risk, go to hoddle, hold on, and then it's market set. So you set your own interest rates and durations and see what rate will get bought. And there seems to be an excess of borrowers. So the rates are fairly high as it is. But it's a way to insulate your risk because, you know, there's no platform

Starting point is 01:19:11 default risk, basically, right? So there are people probably arbitrage in that who are borrowing on there and then relending or using it as leverage, conventional leverage, but cheaper than the exchange leverage or on exchanges that don't have in on platform leverage. So guys, real fast, I wanted to go into something that's very different than what we've been talking about and it involves the Lightning Network and kind of the incentive structure that you guys see moving forward for the adoption of Lightning and the further pegging of Bitcoin into the Lightning network. When I look at this, where it's kind of becoming obvious to me is so you got cash app, you have

Starting point is 01:19:50 all these other Venmo, you got PayPal and others that are allowing on-chain Bitcoin purchases. On Cash app, you're able to send Bitcoin to your own wallet. And when I'm looking at the fees, especially on the network right now, people don't want to have to pay $10, $25 fees in order to send Bitcoin on-chain to their own personal wallet. But so to me, it seems like a natural next evolutionary step is that I would want to convert that into lightning, be able to send things to myself via lightning. But when I think about what does that mean for the platforms that are allowing these transactions, call it Cash App or Square or whatever, you can name it, right?

Starting point is 01:20:35 They don't have much of an incentive to want to start enabling some of this stuff because now you're not using their network and they're not able to keep track of the data and everything else that's associated with using their network. Do you see this as a concern? Do you see this as just kind of a short-term kind of concern because everyone's going to have to remain competitive, so they're going to start opening these kind of things up? And just in general, your thoughts on lightning and the incentive structure for further adoption. Yeah, so we have some, you know, a lightning play. So C Lightning Blockstream is one of the three main lightning implementations. There are a couple more now, but one of the first three original.

Starting point is 01:21:16 And I think that there is generally a bit of a lag in technology adoption in this space, not just with lightning, but with, for example, the network upgrade. So Plan B mentioned a fork drama a few years ago, and that was about a network upgrade. Well, it probably wasn't really about the Segwit feature, but some other kind of scale discussion, in fact. But in any case, the Segwit technology effectively increased the network capacity by two to three times, but only if you used it. So for each person that opted in, it would increase capacity. But even today, you know, the Segwit adoption rates are not 100%. they're maybe 60 plus percent.

Starting point is 01:22:05 And that is because there are popular wallets like blockchain info is claims and does appear to have a quite high percentage of transactions. You could tell because their site went down and then the Segwit ratio shot up for a while and that they came back online. So we believe it. And they've recently announced that they're finally in 2021 about to start rolling that across their different wallet architectures. And they're not alone, right?

Starting point is 01:22:35 There were many, many platforms that took a year or two to integrate Segway. And it's extremely simple thing to do. I think that a developer with the right skill set could get it done, you know, presumably in a maximum of a week or something. So you might wonder, why are they not incentivized to reduce the transaction fees? And, you know, the answer is not, it's typically, there's two incentive problems. One is that the customer pays the fees, they don't. So not their problem.

Starting point is 01:23:06 And secondly, at least for the exchange trading part of it, and I know you were talking about retail payments there, and some come back to that, but for the exchange trading part, the exchanges make most of their money from the bigger traders. And so if they have to pay, you know, a 10-cent transaction fee or a $1 or $10, that doesn't really change their trade,

Starting point is 01:23:29 because they're maybe paying 10 or 20 basis points on the trade, and that's far more money than the deposit. And the traders are also impatient. So when they want to take a trade, they want to take a trade. So they'll look at what the current fee rates are, and they'll double it just to be sure. So they'll tend to push the fees up. So I think most of the high fees are due to traders.

Starting point is 01:23:50 And there are multiple things the platforms could do about it, but they tend to be a year or two behind a curve in upgrading it. Eventually they get there. and you start to see more exchanges integrate Lightning as well now, which is cool. I was actually more excited about exchange lightning integration for sort of retail broker exchanges where I just buy Bitcoin now kind of user experience because it would give you a way to top up a lightning wallet, which would make it into more of a circular economy. So when the merchant, I mean, generally speaking, the users are buying things, right?

Starting point is 01:24:26 So, they're either paying each other, which will work fine, or they're buying things from merchants. And if the merchants, so all the money is going to pile up on the merchant end of the channel, and then they're going to close it. And so if the merchant goes to the exchange and sells, the exchange can basically pay them to send the money back to the user on average. And then you get a nice secular economy. So it's been a bit of an uptick in exchanges doing that. But, you know, they're busy with other stuff, you know.

Starting point is 01:24:54 So when the market gets crazy, they're focused on scaling the trading engine, adding more support staff to bring in more users. So or adding altcoins and defy products and things like that, right? So if you log onto many of these exchanges or you get an email update every week or so, and there'll be half a dozen new coins, right? So that is consuming engineering resources. And regardless of your views about the investability of non-Bitcoin coins, they are, for the exchanges, it's actually, you know, they make money, but it's a competitive ecosystem. If you don't stay at the top of your game, you'll start to lose liquidity to other exchanges. And that's that, you know, that's not good if you're in exchange. So chasing new coins is a way to get a little increment of extra liquidity.

Starting point is 01:25:46 Most of the liquidity is in Bitcoin, most of the volumes in Bitcoin. So it's only an increment. And they also give updates less prominently about deal listings because they fall out of favor after a bit and they don't want thousands of them. They're being something like 9,000 coins at the moment. So I think it's like technology inertia is the problem. But you mentioned another one, which was the cash app. So basically retail wallet like experience where the coins are in custody typically, but

Starting point is 01:26:14 you can take them out. And they are able then to pay user to use. user in platform, and some of the exchanges do that too, or withdraw the coins. So obviously, it would be nice if more platforms like that use Lightning. And in a way that's kind of what Lightning can do very well is it can give you the same kind of scalability almost as a platform like that while having less trust. So you can net people out in fairly real time or net between platforms too, right? You can have a big credit line.

Starting point is 01:26:48 So you don't even need a credit line. You know, some people had credit lines between exchanges and things like that. So if you have a lightning channel, you can sort of, you don't even need the credit, right? You can just net it out as the balance moves during the day of users, net paying wallet users of one platform or the other. So I think people from a technology sector will tend to, you know, not your keys, not your coins. And obviously, I think that's a very good advice because there is custody. risk in this space, and it has been people, you know, and it's not, you know, it's not all in the

Starting point is 01:27:21 past. There's the Mount Gogh, but it was news in Turkey just, you know, this week that was the exchange seems to have gone offline and funds are not redrawable, so it happens. So, yeah, I think that it'll be good to see more lightning. It's the same kind of thing with liquid as well, because that is, you know, a technology that is a layer two, a different kind of layer two that can hold not just Bitcoin, but also stable coins like Tether and other instruments like the BM, the blockchain mining note we're talking about. That's a liquid asset. And so, you know, users can use it as a wallet, as a way to transact peer to peer, even do like OTC swaps per to peer, store the assets in a hardware wallet. So it has a Bitcoin-like experience.

Starting point is 01:28:10 but it also is faster for exchange to go from cold wallet to exchange and be ready to trade within a couple of minutes. And that can be important with volatility that you need to add more collateral if you have a margin position to avoid liquidation. By the way, the price is back at 50,000, I see. So that's, and you also get confidentiality because Liquid has confidential transactions by default. So you don't get the kind of open source intelligence that drives the whale calls or you see tweets about some large number of coins being deposited on an exchange, which some people will try to use as part of their open source intelligence for trading. Is there any question that you guys have for each other?

Starting point is 01:28:55 Adam, I always, this is a question. I've been researching and nobody can tell me the answer. And if there's anybody who can, maybe Adam, it's you. Because we all believe. leave, I think, in the halving cycles, right? So there's a four-year period in Bitcoin. The price sort of moves around that. But why is there a four-year period? Why not a three-year? Why not a five-year? Why not a daily adjustment of the number of coins that's being mined? Why is non-linearity in there? Yeah, I don't know. I mean, it certainly could have been continuous, right? And some people were even arguing that it should be changed to be continuous. And it appears that you could even design such a change as a soft fork if you really wanted to. But I think that obviously

Starting point is 01:29:48 there would be resistance to that because people don't want to see any fundamentals about Bitcoin changed. So there's that. But I mean, I'm also finding that the halving is quite an interesting economic effect and maybe positive in that sort of being a heartbeat for market cycles or something. So it seems to have a market effect. If it was continuous, you wouldn't have this effect. So I'm thinking it's nice. But it's not clear, you know, like it seems like, as you say, it could have as easily been continuous or a different period. I mean, I presume a lot of the numbers in Bitcoin are sort of round numbers or whole numbers for it looks like for tidiness, you know. So and even the 21 million coins, it is

Starting point is 01:30:34 suspected to be to do with the size of the maximum sized integer that fits in an unsigned 32-bit CPU instruction, sort of programming, formatting, derived number. So, yeah, and then like half versus three, well, probably because it's easier entirely at a program a power of two, so it would be like two or four or eight, but, you know, why that and not continuous? I don't know. I mean, I think some of the parameters probably wouldn't matter, you know. So if there had been exactly half as many coins, they would just be worth twice as much. And so a lot of numbers could be different and have the same effects, but the sort of supply inflation rate is interesting, you know, because it could have been different and worse, and it seems to be very nice. I don't know how Stochi Air picks.

Starting point is 01:31:33 that curve, but it seems to work great, right? I have an opinion on it. I think that it has to do with gaining entrenchment. I think that if you had it as a fixed rate of difficulty, I'm calling it difficulty, but the having, right, if you just had it as a nice linear curve like Adam was describing, you would have the price action not take these breaks where it would just kind of just keep going, going, going, right? And in my opinion, it wouldn't have given you the decade that you've had in order for the

Starting point is 01:32:07 engineers to continue to build without interruption from regulatory pressure. So it almost seems like every time that we've reached a fever pitch in the price, I know in 2017, near the end of 2017, it was coming up in White House press briefings that this was a, hey, what's going on with the Bitcoin price? It's like, you know, $15,000 and is up whatever thousands of percent in the last a year and a half, it was becoming a topic. And then as the price calmed down, it just literally went away. No one talked about it for two years. And you would have never had that if you didn't have this four-year quantum leap. That kind of takes place. Another reason that I think four years

Starting point is 01:32:51 was selected, and then this is all, you know, obviously Preston Pish's opinions on whatever, I think four years was selected because when you look at Moore's law, you have the processing power has doubled every two years. So when you think in just that rule of thumb, you want to enable miners to, new miners that are coming into the fold, to have an advantage over the old miners so that they can carry the burden of the supply shock that occurs with mining half. as much. And so by waiting out a certain period of time, whether that would have been two years or four years or six years or whatever, I think four years was just kind of a spitball of, hey, that's going to have four times as much processing power than people who were buying,

Starting point is 01:33:43 buying rigs at the previous halving event, and they'll be able to weather that supply shock and be profitable in order to continue to carry the torch as you go through that shock. So I think it was just like a look at Moore's law and saying, every two years it doubles, so we'll be at a 4x improvement in processing power, and that'll assist in carrying that burden as the system and the network fuels that shock. Surely it worked perfectly. Oh, my God. It's working pretty darn well, that's for sure.

Starting point is 01:34:17 Adam, did you have anything or Plan B? Did you have another question? I heard some people talking about other forms. of the yield extraction using options. I was curious how that works if it's not a kind of proprietary thing that you'd sooner not explain. Oh, no, no. So that would be the comfort call writing and that would be like having a Bitcoin, buying a

Starting point is 01:34:45 Bitcoin and then writing a call option, so selling a call option. What that gives you is basically a higher premium than the the futures premium, let's say the futures premium with the cash and carry rate is like 20% right now, 25. The call writing strategy would give you like 40% premium up front, so you don't have to wait for it. You have it upfront. And that caps your upside to 40%. So if the Bitcoin price goes up, you will lose your Bitcoin, but you will have sold it for 140%. So 40%, 40%. So 40%, profit. If it goes down, the buyer of your call option will not call the option. And you will keep your Bitcoin. You will keep your 40% premium. But of course, you will have the loss on your Bitcoin.

Starting point is 01:35:38 So that could be 10%, 20%, maybe even 80%, if that happens again. But in that way, the call option writing strategy also works as hedging. Because if the price would drop 80%, you would have your premium of the call option, you would have your Bitcoin and you would have your loss, but your loss would not be 80%. It would be 80% minus the 40%. It would be basically you have a higher premium up front, even, but you have a small downside risk. You keep that small downside risk. And of course, you cap your upside risk to the premium that you receive. So there's some non-linearity. It's not a future. So some of the losses are for you. And that's... That's how you do it.

Starting point is 01:36:25 But you basically get the futures premium plus the volatility premium. So the volatility premium. You should see the trade and every option trade as a volatility trade. So you should write an option. Should you do the covered call writing when the implied volatility spikes? At the moment, there's a spike. You should deploy that strategy and then write all the volatility down and then buy it back or write it out.

Starting point is 01:36:53 It's a very nice strategy. especially since the implied volatilities are 80, 90, 100%, which is crazy. Adam, I got a question for you. So it was brought up recently on a podcast I was listening on Peter McCormick, where he was interviewing Bill, who runs his own borrowing and lending platform. And he was bringing up the concern of fungibility. And from what I understand, I was talking with Jimmy Song about this as far as the taproot upgrade, potentially providing a technical.

Starting point is 01:37:24 solution to the fungability concern that some have that governments could potentially create on the fungibility of Bitcoin. What are some of your thoughts on that? I think there have been typically some form of privacy or fungability improvement in new versions of Bitcoin as they come out, either at network level or in a protocol. And Taproot and the Schnoor signatures that come with it are both help in that way. And, you know, it's not a very important. not a silver bullet, but it does incrementally improve fungibility because it reduces some wallet or use case fingerprinting. So, you know, part of what the open source intelligence is doing is it's trying to correlate coins as belonging to the same wallet or belonging to the same user

Starting point is 01:38:14 like that. And with, you know, with, so with with with with with with with coins generally, there's a tiny smart contract attached to them. And a contract. The contract will be different depending on a type of wallet or type of use case. So if it's a lightning channel establishment, you'll see it because it's a different contract when it's closed. And the contract is revealed when a channel's closed. And, you know, the green wallet has a multi-sig, which is kind of two of two multisig and a time lock, and that's visible too.

Starting point is 01:38:48 So if you were using that wallet and, you know, I pay somebody who is, you know, a single-sig wallet, it will be obvious. So there's change. And the person looking at from the outside wants to know which of these coins are change and which is the payment. And maybe you can tell because all the multi-sig ones are the green wallet and all of the single-sig is the other wallet. So you can tell which is the change or which is the payment because they have a different discernible type. And so with Taproot, you don't see that anymore for two reasons. One is you don't have to reveal the full script when you spend it. You only reveal the normal case and there will be, you know, an exception like, oh, I need to use the time lock

Starting point is 01:39:29 clause and then you'll reveal it if you need to use it. But typically you don't, you know, 99.9% of these never exercise the time lock. So you get more privacy in the default case. And the Schnor's signature can also disguise or not use a block space with multi-signatures. So with Schnor, a two-of-two signature looks indistinguishable from a single signature to the blockchain, which improves scalability, and it means that you can't tell single-sig from multisig, and you probably can't even tell single-sig from a lightning channel set up or close in the normal case, because the lightning channel is also, you know, but it's got infrequently used branches in its logic that the other parties,

Starting point is 01:40:14 wallet, stopped responding. I need to close a channel. So I'm going to use this escape clause to unilaterally close it, rather than collaborate with the other party of close it. And that's not so infrequent. So if you don't need to do that, then also people won't be able to tell. So it provides that sort of anti-fingaprinting, which is an incremental improvement. Now there's less data to analyze to, there's more ambiguity about which is change and which is not.

Starting point is 01:40:37 But, I mean, there are more things that could be done. And that was actually how the, with Blockstream, before Blockstream, I was interested in trying to improve Bitcoin's fungibility and privacy. So I proposed the confidential transactions as a way to do that. And it encrypts or hides the value of the transaction. So the transaction is still there. You can still look at addresses of what's going and where, but you can't tell whether it's, you know, a tenth of a Bitcoin or ten Bitcoin's from the outside.

Starting point is 01:41:11 People, part each of the transaction, can look at that. And that makes, you know, another improvement because you won't be able to tell, sometimes you can tell what's changed by the amount, right? It's an even amount or, you know, it's an odd amount that looks like that would have been changed. And it takes that away. Plus, I'd say there is an advantage to not broadcasting the size of a transfer for a security basis. You know, if you were operating a business and you sent a large transaction, some of these transactions are, there's a pay-to-peer network, which could reveal your IP address and therefore your location, and you don't want to advertise to the world the location of larger coin, you know, larger wallets.

Starting point is 01:41:54 It could be a security risk. So you get some kind of security advantage. So we went on to form Blockstream and implemented that extension and liquid. And it's, you know, it's a Bitcoin compatible kind of technology. So maybe one day we'll see a more space optimized version of that and make its way into Bitcoin. I've been an interesting discussion to have because, you know, scale, scale gets people who prefer retail payment use cases for Bitcoin, arguing their case as opposed to the store of value, you know, censorship-resistant payment use case. But I think there's different sets of people agreeing and disagreeing. If you would say, let's, you know, let's have an

Starting point is 01:42:36 initiative to add confidential transactions to Bitcoin. And I think it's an interesting thing to consider because it doesn't in one go remove the transaction graph. So people can't say, you know, Bitcoin has become zero cash or something like that. But on the other hand, it does incrementally improve things. And in a way that's beneficial, you don't, you know, if you do a bank transfer, you don't reveal to the public at large, your bank balance, all the size of the transaction. So in some ways, Bitcoin is less private than a bank account from that point of view. So it could be an interesting discussion to have, and maybe we'll get to see that in the following years at some point. Well, gentlemen, we've been going for nearly two hours here. And I do

Starting point is 01:43:18 I just want to personally thank both of you for your time. Is there any closing comments or anything that you guys want to throw out there before I close things out? Thank you, Adam Preston. It was a great chat. And I'm so excited about the next phase of this bull market. And I'll be watching all the things we talked about, the basis, futures basis contango spread, the implied volatility in the options and all the on-chain parameters, as well as the air-as-eye, of course, watching it like a hawk. I'm very excited about the next couple of months.

Starting point is 01:43:52 I mean, I'm also a sort of value investor kind of buy sort of trading pattern historically, and that's the way I look at Bitcoin today. If it goes down a bit, I feel that it's cheap and I buy some more. And, yeah, we'll see how it plays out and maybe have a play with some of the sort of long-term call options as well. I haven't done that much for those yet. that will be interesting to play with. And on a blockstream side, obviously, we're busy with these blockstream notes at the moment. And so if people are interested in that, they should

Starting point is 01:44:27 go to stocker.io, stokokr.io, and have a look at the notes for non-U-S. investors. I think, you know, in our view, it's very attractively priced and an interesting kind of risk price, you know, sort of a diversification of volatility that still, you know, could be a Bitcoin on Bitcoin trade or a way to acquire Bitcoin with less volatility to gain an entry point because you do get people who will newcomers who will get stuck in a decision, they don't know whether the price is going up or down, and then they'll just sort of sit on the sidelines. So you can, you're much less sensitive to entry price with mining. And, yeah, there are also people who are very far into Bitcoin who even do.

Starting point is 01:45:15 it as a kind of an alternative to selling Bitcoin to reduce the volatility on some of their Bitcoin and see where that goes. So it has that potential use too. So great talking with you, Bill. So I'm going to have links in the show notes. I know Plan B has a website, PlanBTC.com where you can go and you can see all of his previous interviews, some of his white papers and things like that that he's written. Adam, I'm going to have a link to your note that you guys.

Starting point is 01:45:45 have. We had that in our previous conversation as well, and you can also go to blockstream.com. We'll have links for all of that in the show notes. Gentlemen, thank you for your time. This was so much fun, and I would really like to do this again in the future. Thank you. Hey, so thanks for everybody listening to the show. If you enjoyed the conversation, be sure to subscribe to the show on whatever podcast app you're using. We really appreciate that. And if you have time, leave us a review. So thanks for joining us this week, and we'll catch you next Wednesday. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com.

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