Yet Another Value Podcast - Bitcoin futures arb and trading the crypto market with David Fauchier

Episode Date: May 20, 2021

The crypto market currently feels like the wild wild west. It can take only a week or two to run through a full cycle (a bull and a bear market), and coins that are explicitly a joke can be valued at billions of dollars on the back of a tweet from the right celebrity. David Fauchier, fund manager at Nickel Digital, pops on to discuss how a professional approaches investing in the crypto world. Topics include bitcoin future arb, how to approach the risk of fraud or an exchange blowing up, and why it makes more sense to invest in crypto directly than to invest in mining.My post on BlockFi and Bitcoin Futures Arb: https://yetanothervalueblog.com/2021/...David's Twitter: https://twitter.com/dfauchierDavid's other podcast covering the crypto market: https://blog.thinknewfound.com/podcas...Chapters0:00 Intro1:50 Overview of Nickel Digital and David's background4:55 Bitcoin futures arb overview11:05 Risks and negatives to the arb trade.15:58 Bitcoin : Ethereum :: Unproductive : Productive?23:10 Digital Horses and other productive uses for blockchain25:40 Fraud risk in crypto trading32:00 Could the crypto exchanges blow up?50:10 Does cryptos 24/7 nature and extreme volatility minimize blow up risk?53:20 Buying crypto versus buying miners1:04:30 How David evaluates managers in the crypto space

All right. Hello and welcome to the Yet Another Value Podcast. I'm your host and the founder of Yet Another Value Blog, Andrew Walker. And with me today, I'm happy to have David Fauci. David is a fund manager at Nickel Digital. And Nickel Digital is a, they're a crypto and digital asset focus firm. David, how's it going? Really good. Super happy to be on your part of my big fun. Hey, I'm really happy to have you on. And let me just take that. And I'll start this podcast the way I do every podcast. Well, I'll start a little bit differently. I just want to give a disclaimer. you know, we're going to talk about a lot of different cryptos. We're probably going to talk about crypto futures, a lot of different stuff. Everyone should just remember. Nothing on here is investing in vice. Everyone should do their due diligence. A lot of stuff we're going to talk about definitely has a lot of risks associated with it. So just everyone keep that disclosure in mind. Now let me turn to pitching you. You know, a couple weeks ago, I'll put the links in the show notes, but I posted an article talking about Bitcoin's Future Arb. And a bunch of people reached

out to me, including you. You reached out, you and I did about an hour long. long call and you just blew my mind with how well you understood the market. We went into a bunch of stuff and I think we're going to cover a lot of this stuff on this podcast. That's what I'm hoping for and I think people are going to enjoy that. But we went through a ton of different things and I walked away from it thinking like there is just no way in the world I should try to do this myself. A lot of times people will be like, oh, I want to invest in stocks. Like, hey, you can do that. But you know, if you're a dentist, I don't go to you and say, hey, I want to pull my own teeth. And when I walked away from you, I was like, if I try and trade any of this stuff, it is going to be very much me pulling my own teeth.

So I think I'm super excited to have you on. I think this is going to be a fascinating conversation. And yeah, that's a longer than normal intro. But since this is a little bit of a different podcast, maybe we could just flip it over and turn it over to you. You could maybe give us a quick background, talk a little bit more about Nickel Digital is. And I know you're a fund manager for them, what you specifically do. Sure. So, yeah.

Nickle, yeah, Nichols are about a 20-person, crypto-focused. All we do is crypto, asset manager based in London. We have four products, kind of four funds, two of them kind of more on the passive beta side and two of them on the alpha, market neutral, beta-neutral side of things. I manage one of those called the Factors Fund, which is pretty much a multi-manager platform. So we allocate to outside managers on a managed account basis. So if anyone's listening and, you know, Quants and Crypto, we would love to chat. Please reach up.

That's kind of my pitch. Yeah. So the fund's been around for about two years. Just to put your fund into perspective, I think a lot, you might quibble with the definition a little bit, but I think a lot of people are familiar with pod shops where there's one overarching manager that allocates money to different little pods and traders and do stuff. I think it would be fair to say your fund is similar to that. And if anybody is, what you're saying is if anybody's quant trading and kind of looking for

that type of capital, they should reach out to you. Am I saying that correctly? Yeah, thanks for clarifying. So we do allocate to certain internal pods that are run by managers in-house. But most of what we're doing is allocating to external managers, typically to prop shops in the crypto space. And if you are a prop shop or a crypto trader and you're looking for capital, please reach up. Perfect.

So, yeah, the firm is a little over two years old. The first fund, that kind of flagship arbitrage fund launched in May of 2019. So it's seen quite a lot. And the background of the partners is in kind of old school fixed income arbitrage. And so hence the ARP kind of focus of that first fund. And yeah, I think, you know, things have generally gone well. And I joined them in November to run, to launch and run this new fund. And prior to that, I ran a market neutral fund of crypto funds in the crypto space

called Cambridge Capital and have been doing that since, had been doing that since late 2017 when kind of that market started to actually allow for these strategies to get run. previous to that worked in tech and had been kind of dabbling in on kind of research and investing side in crypto since late 2012 and meeting with some of the really kind of early managers from 2014 onwards. Perfect. All right. And I think that's a great background because it shows why I was so excited to talk to you and have you on because, you know, A, you've traded this stuff yourself. B, you're looking for managers who are trading this. So you're thinking through, I mean, you're like 20 steps ahead of me and thinking through it. But you're thinking through all of these

risks on a daily basis when we're looking at crypto going up and down, all the different type of arbitrages. And obviously, if you're managing a lot of different quant managers, you know, all of them are going to be exploring different strategies and different ways to talk about it. And you have to think about all those risks. So that's why I was so excited. So let's turn to the thing that we actually connected it on. And that was my questions on arming crypto futures, right? And the basic one was when I wrote this at the time, you know, Bitcoin was trading around 50,000. We're talking on an interesting day because Bitcoin has been pretty volatile on Elon Musk's tweet recently. But, you know, Bitcoin's spot, the current price was

$50,000. And the December price for Bitcoin's futures was $55,000. And that presents, and this is very typical in finance, a contango trade, a futures arm trade, where you could buy Bitcoin today, sell the future in the future. In December, you could just deliver that Bitcoin, and you would capture a, you know, it would be a riskless profit, assuming that you could hold to completion, right? You sold it for $55,000 in the future. You bought for $50,000 a day. You make that $5,000. thousand risk-free over nine months. That's 10% gross. Even better than that annualized. That's incredible stuff. And I was looking at this and wondering, how the heck can this exist? So I was hoping you could start this off by just kind of talking through that futures are, but I know there's

lots of different markets that trades on. But, you know, what is that, why did that future arms exist? And do people, can people take advantage of it? Yeah. So it's one of these trades. it's extremely simple conceptually. It's the oldest trade in the book from kind of traditional markets. People have been doing this for a very long time. And so there's been a lot of head scratching. The basis that we've seen in futures and on the perpetuals in crypto has been pretty blown out for a long time, but it seems to sort of have gone mainstream in the past month or two. I think kind of precipitated by this guy called Arthur Hayes, who runs kind of the first big derivative exchange called Bitmex. And he wrote like a long piece on this that just like

lays out the whole trade for you, like with all of the maths and stuff like this. And since then there's just been more and more and more of it on Twitter and people talking about it. So let's see how long it lasts for. But I think there are some very good reasons that you can point to to kind of explain why that basis exists. And part of that is just kind of the raw demand. for dollars in the system. And the other part of it is like the risks, which if you really think them through, I think are pretty nuanced and you really need to be factoring them in because there's a lot of different ways of getting blown up on this trade. But yeah, like the historic basis is annualized like between 10 and 20%. We saw periods of time, you know,

especially kind of late Jan, Fab, and over the past few weeks where it was kind of hitting 40% annualized, which is insane for a purely market neutral trade. And when the basis kind of blows out like that, it's really a function of just effectively a demand for leverage in the system. So if you, there's all sorts of reasons why you might want that leverage, one of which is speculation, but there are other sort of more kind of quote unquote legitimate reasons. But what you effectively get into it is these situations where there's a very high demand for leveraged exposure, either as a hedge for something else or just because people, you know,

want to get like mad degenerate long on the stuff. And this pushes the price of the future out. And I think the difference with traditional markets is like there's basically no cost of storage. So you can't get into these situations like, you know, with oil where it's structurally always needs to be in a contangelo because there's, you know, like on physical delivery, there's a real cost associated with storing the oil. And similarly, I don't think you can get into these kind of negative scenarios where, you know, oil can trade negative, again, because like there's no cost to storing Bitcoin. There's always going to be marginal demand for Bitcoin at zero dollars. Yeah. And a zero dollar price. And this is something that I put in my article. Again,

people can look. You hit the nail on the head. But last year, oil went to negative for a while. And obviously, if oil is negative in one month and in the future month, you know, oil's not going to be negative. That's a big trade. But the reason was because oil, you actually have to take delivery and you're going to have to fill your swimming pool. You're going to have to fill your swimming pool up with it if you take that delivery or something. But Bitcoin, you know, delivery is pretty damn simple. You're just kind of transferring bits back and forth. So yeah, please. Exactly. Yeah. So you've got this floor there. And then so the future typically trades at a contango because, I mean, statistically, if we just look at Bitcoin, like the price is generally trended upwards. So

So, like, there is a, if you look at the distribution, like, there is a right skew to that. So partly, you know, who wants to be short this stuff long term? And partly, you just have this kind of demand for leverage, which is quite big in the system. And it leads to these kind of crazy situations where, like, a lending desk will call you up and say, you know, can we borrow dollars on a three-month term for 15%. And you're like, what do you mean? Like, this doesn't exist.

no one is willing to borrow dollars at 15%. And in crypto, it happens because these lending desks effectively are turning around and lending the dollars back to people like us who then go and up the basis on the future, which is even higher. And I wasn't the one, I mentioned this in my article. I got this from other people, but correct me if I'm wrong, but that is one of the reasons a lot of like, you know, the blockfies and stuff can offer such high interest rates on cash deposits, right?

because if you deposit your cash with them, I mean, yeah, they'd love you to trade crypto and do it. But if you just deposit their cash, they can take it and they can use it to lend out to people like you or your pod managers who are then going to go exploit this arbitrage. So they borrow it eight, they lend to you or not you, but someone like you, a pod shop at 12, 15, whatever. And then you go put this futures arb on at 20, 30, 40 percent annualized or whatever. And everyone's happy because everyone's making a lot of money. Yeah.

It sounds crazy and too good to be true. and so let's dive into the negatives of it. The first is like these situations occur during bull markets and these markets aren't always in bull markets. You typically have like a year of bull market and three years of flat or down. So if you actually like average this out over the whole kind of cycle going back to the last bull market we had

in 2017, kind of popped in early 2018, you're averaging like an 8% to 10% return over that time. in like a pure like funding rate, so where you short the swap or a basis trade. Call it like a 10%. And so then you have to kind of look at what you're getting for that 10%. And part of it is like, well, what's my risk-free rate or my alternative investments? And what is the premium that I'm going to require from the market if I'm going to go and invest in this kind of crypto kind of basis trade?

Because to put the trade on, you need to deposit collateral with the counterparty. And that's like the big risk that you're underwriting here is, do I trust the exchange on which I'm depositing my collateral? And so you'll see, for example, the basis on the CME is just structurally lower than elsewhere, even though it's a huge pain in the ass to trade there, even though the margining requirements are like they suck, the reference price sucks, the market closes at night and over the weekend, but it's pegged to an asset which doesn't. So you've got a huge gaping risk. There's all sorts of reasons you wouldn't want to trade on the CME, but all of them, if you just look at the price of that basis, are more than compensated for by the lack of counterparty risk there. So, David, let me jump in and ask two quick questions. So the first one, just to confirm and clarify, so in my example, I mentioned Bitcoin's currently trading in at $50,000 and Bitcoin futures are at $55. And what you're saying is on the CME, it might be Bitcoin 50, Bitcoin Futures 55, on a slightly dodgier exchange, like if I watched the Andrew Walker exchange, it might be Bitcoin Spot 50, Bitcoin Futures 57, because people are factoring in some of that counterparty risk. Yeah, it was 60.

Yeah. Okay, perfect. And then I guess the other question, so right before we had talked about that, you had mentioned, hey, like, you know, right now the annualized on it is really good. you know, it might be 20, 30 percent from exploiting this futures trade. But you said, look, these things go in cycles. And when the market's not in a bold market, there's not really a futures trade to take advantage of. So if you kind of average it over a full cycle, you get 10% annualized. And I hear you on that.

But my two pushbacks would be, A, I mean, the crypto market's only 10 years old. So how can we really be talking about, like, what the cycles look like and everything would be one? And that's more just conceptual. But my second would be, again, I hear you on. on that. But, you know, to me, you wait for the bull market. You allocate as much as you can while it's yielding 20, 30, 40 percent annualized. And then when it's done, you know, you can go allocate to other stuff. You can just, you can put it in the SMP 500 if you want. You can put it in bonds if you want. But, you know, anytime something's 40 percent annualized, that's really attractive.

And it does raise an eyebrow while it's there. And I hear like, oh, yeah, you know, the market's pretty hot and it won't be that way for long. But still 40 percent annualized. I suspect that is what you do. But I, if you could comment on both those pushbacks, I would give you. So on the cycles, crypto cycles tend to last about four years. So like one year of bull, three years, you know, one year of bull, one year of bear, two years of winter. One year of winter and one year of kind of like things starting to drift upwards again. But you typically have like this one year of like frenetic, maddened, like, you know, nuts markets where this stuff is on CNBC every day. And this was true in 2017, and then everybody forgot about it, and now it's come back.

And my personal belief is, like, things will get silly, things will go up, and then it'll pop, and it'll go down, and everyone will forget about it again, and, you know, we'll go back into a cycle of, well, it was all kind of a bubble in a Ponzi scheme. And underlying all of that, I think there's an enormous amount of kind of things going on in the ecosystem, a lot of people building really valuable tech, basically. And whenever you have these bubbles, you know, there's this kind of colotoporized concept of productive bubbles versus unproductive bubbles. Like, you know, the gold rush in Alaska was an unproductive bubble. Like lots of capital got thrown at this.

And then what got left was a bunch of holes in the ground. The internet bubble was a productive bubble. You know, lots of capital got thrown at it. Yeah, everybody got wiped out, almost everyone at the end of that. But what got left behind was like a global network of like trunk fiber optic cable that allows. for the world to have $40, like, broadband in the 2000s. Let me, I love that point. That's such a great point. And I'm going to use it to skip way, way ahead. And we'll come back to the basis trade in second. One of the things, you know,

I am, I'd say a crypto skeptic. And I look at something like, you know, Bitcoin started and it was, hey, this is going to be the digital future. This is how people are going to pay in the future. And at some point, it morphed into, oh, this is just digital gold. It won't have any use, but it'll just be a store of value. Yeah. So would I be crazy if I told, you, I think a lot of coins, you know, Bitcoin and Dogecoin, which they even quoted it as it's joke currency. I think those are unproductive bubbles. Maybe people disagree on Bitcoin, but I think but I look at something like Etherum, which actually powers a lot of these NFTs. And I know people think NFTs are joke, but a lot of there's a lot of fun and they power a lot of interesting

things. Or you and I think at the end we'll talk Defi, which I think Defi, a lot of it is powered by Etheram, but Defi allows for a lot of interesting applications on the blockchain. Would I be crazy if I, if when you say productive versus unproductive, I kind of thought, oh, Etherum, and maybe Ethereum's not the winner, but Etheram and some of these Defy stuff, that is actually a productive bubble. Would you agree to disagree? How do you think about that? Yeah, like, broadly. I mean, I think like Bitcoin goes off and money comes into the space generally, and specifically like the mechanism that I think is productive in all of this is venture capital funds with like VC managers who actually understand the technology and are making investments

into real teams building real stuff, get funded. And like right now, every VC fund in crypto that's open is like way oversubscribed and like having money thrown at them. That money then gets locked up. And we've seen this cycle before. Like the money basically gets locked up in VC funds, a portion of which are bad and will make bad investments, but a portion of which are good. And I think there are some extremely high quality venture allocators in the space.

And it basically means that if you're, very high quality team building something interesting in crypto, there is money available for funding. And you will get funded and you'll be able to go build this. And so, yeah, as with restaurants and dentists and anything else, 98% will fail as with any startup. But that 2% that kind of succeeds ends up building a lot of value. Could you give an example of something that's getting kind of built out on the blockchain or with this VC money right now that you think you know, has the potential to build a lot of value? So you mentioned Ethereum, which is, you know, the way maybe to step back,

I think people have been trying to build internet money since the internet began. Like, if you look at the original HTTP spec, like when you get a 505 error on your computer, you know, page not found, there's a whole kind of spec around these HTTP errors. And we have specced errors for like payment failed, for example. that have just been sitting there since like HTTP was created and, you know, the web came out. No one was able to build internet money because there were a bunch of kind of technical problems. And then someone came and said, hey, here's Bitcoin. It solves these problems. Here's like an internet money. And like what you need for that is basically like security

and scarcity. And the concept of digital scarcity did not exist pre-Bitcoin, like provable decentralized digital scarcity. And it sort of introduced this kind of architecture. And I think that's interesting, at least academically, whether or not it works. But a bunch of other people looked at this technical architecture and said, hey, I can use this to build, to kind of solve my problems, which have nothing to do with trying to create like an internet native currency. I have nothing to do with currency at all. One of these people is Vitalikbutrin, who goes on to found Ethereum.

And what he was trying to build was like a decentralized cloud. So today, if you want to run a program, you can either run it on your computer or you can run it in the cloud, yeah? And there are all sorts of benefits to running it in the cloud. But if you run it in the cloud, you're basically running it on AWS, Google Cloud, Ali Cloud, the Chinese clouds, basically, all the Western clouds. But there's like five different companies you can go and do this on. And there's a lot of centralization now. And centralization generally is not a good thing in terms of, if you think about computer security. And basically, Vitalik was trying to create an open, decentralized computing platform.

So like a real cloud that sort of just sits in the ether and is everywhere and can be accessed from everywhere. And what he basically did is he took the architecture of Bitcoin and created effectively a marketplace. Like, Ethereum is a marketplace for computational power. So I want to run a program. I can upload this program basically onto into the Etherium and you Andrew who've got like a really kick-ass new MacBook Pro that right now is running at like 10% capacity because what we're doing is running a Zoom meeting can actually rent out your compute power to the network and get paid for it and for anyone technical in the audience like I apologize

because I'm oversimplifying but what Ethereum basically is is like it's a product protocol, so like a network, if you will, that allows people that don't know or trust each other to coordinate their work. I will pay for the service of computation and you, Andrew, can provide it for a fee and they'll get paid. And if we look at all quote unquote cryptocurrencies or 95% of cryptocurrencies out there, they're not trying to address a currency use case whatsoever. They're pretty much trying to build like these decentralized marketplaces for.

for compute, for file storage, for marketplaces for X. And that's, like, I think that's kind of the venture side of crypto. Like, one thing is there's Bitcoin, and Bitcoin is the only crypto project, which is mature from a technical perspective. Like, it's built, and it's either going to be good or not good, worthless or not. And, yeah, it's basically magical internet money. Like, it's a digital, scarce thing, and you can choose to ascribe value to that or not. that's it.

There's no magic to it. Everything else is like early stage technology that keeps getting updated, upgraded, and improved. So like Ethereum is about to go through a major upgrade in July. It went through one last year. It's going to go through another one in 2022. And it's like a system for a marketplace for computation that keeps getting better. But it's basically early stage venture investing. 98% of the stuff is going to fail.

and in my opinion, like 2% of it is going to become like core internet infrastructure, like public open infrastructure for the world in the same way as like WebRTC, which is another protocol, is what's allowing this conversation over Zoom to happen. Like it's just like a piece of the internet stack. I think that's where we had it on everything else. Yeah, look, again, I've been a crypto skeptic, but just as I was preparing, I mean, as I started looking at the Bitcoin Futures ARB and as I was preparing for this podcast and doing some other stuff, I've told people before, but me and some friends bought a digital horse and used Etherham to buy the digital horse and the whole thing. And it is a complete joke, but we have had so much fun with it.

We're racing him tonight. If anybody wants a copy of a race, I'll send it to him. They can just ping me. But I mean, digital horse, it's a joke, but it's fun. And it kind of opened my eyes to, I could see how Etherm has a lot of network effects. And it was the first time I looked in, I was like, oh, it kind of started to click. And I started having it in my head, like, yeah, Bitcoin's digital trading sardines. And I've never thought that made sense.

But Ethereum seems like there is something there that could have a lot of long-term value. We'll go back to the Bitcoin futures in a second. But if you want to say anything on what I just said, I think it was just some reason. I'll just give another example of like, well, I'll give two examples. There's another quote unquote cryptocurrency called Filecoin. And that is literally a decent. centralized marketplace for file storage. So I have spare space on my computer. Andrew has too many photos. You can either chuck them on all kind of on Apple Cloud or ICloud, sorry, or you can just

like put them on file coin on the file coin network and I can like offer up my free hard drive space and store your files. And there's like a crypto network in the middle that like governs the relationship, makes sure, like enforces the rules, makes sure that like I don't tamper with your data. that I don't see your data because it's encrypted, that I don't lose your data, and that I get paid for storing it correctly. What would happen? And tell me if that you just simplified it to make an easy explanation. But let's say I rented out a gig of my computer onto Filecoin.

What would happen if I lost my computer or my computer broke or something? So you lost a gig of your data. So, yeah, I oversimplified. But like, what actually happens is like if I'm, you know, if I want to store files on Filecoin, they'll basically first get encrypted and then they'll get broken out into different packets. and then they'll be replicated. And so there'll be, say, three different versions. If I store one photo, that photo is going to get broken into packets.

Each packet's going to get duplicated twice. So there'll be three versions of it. And then it'll be kind of disseminated across the network. And so you will be storing thousands and thousands of random packets from different people. And when I want to retrieve my photo, I sort of ping the network and say, hey, I need my packets back. And if your computer's down, someone else will have those files. Perfect.

Okay. That makes tons of sense. That makes tons of sense. So let's turn back to, that was super helpful. Thanks. Let's turn back to the Bitcoin futures argument. We started touching on a lot of it, you know. And I think there are three risks to it.

We started touching on some, but we'll just walk through them again. The first one, fraud risk. You know, you mentioned Bitmax. And I remember BitMex well because there was a New York Times article where the guy who wrote that paper, I think you said, the CEO of BitMex. Max, what's his name, Arthur Hayes? He got indicted in federal court, right? So I think your first risk is fraud risk. CME is not going to be a fraud, but a lot of these exchanges, sketchy actors, a lot of these coins and stuff sketchy. So how do you think about fraud risk there?

So, yeah, I mean, like, you know, if we back out the cyclicality of this trade, let's say, you know, simplistically, you're left with a 10% kind of steady return. And so, like, what are you, you know, what are you giving up for that 10%? A lot of it revolves around variations on counter-party risk. So, like, the real question is, like, how do I price these risks? So we can kind of walk through them and walk through why, like, in my opinion, it's a good trade. So the fraud risk is certainly that, and we have had, like, exit scams with exchanges where, like, someone sets up an exchange, it, like, does really well in the first few months.

No one knows who the founder is. It's not based anywhere. It's just basically a website. And then they just run off with the money. This has definitely happened in the past. It's definitely possible. If we look at the top, you know, 10 exchanges, and there's really seven big exchanges right now that are all kind of competing with each other.

These guys are making somewhere, you know, give me some rope here, but they're making like 100 to 200 million in free cash for every quarter. Like, they are absolutely printing money. You could run away with, you know, the $2 billion Bitcoin or whatever that's held on your exchange. But remember, like, the ledger's public and everyone knows that you own that Bitcoin. And if you did kind of do a rug pull and just, quote, unquote, kind of disappear with the money, like, it's really hard to hide $2 billion Bitcoin.

And those will then be tagged effectively by the community. no other exchange is going to accept the stolen Bitcoin. So how do you actually cash up? So the Bitcoin sits in a particular address, like Bitcoin address. And we know for each exchange roughly, like we can cluster the addresses that are associated with that exchange. So if the founder of the exchange just kind of runs off with the Bitcoin, you know, he runs away with the private key. The Bitcoin's still sitting in the same address. He moves it to another address.

That move is public. So then, you know, even if he's moved it to another address, what do you do then? Like the end goal is surely to cash out, right? So. And where do you cash out? How do you cash out? So I guess your answer to this risk is there are seven big exchanges that are making enough money that these are real businesses.

So if I launched the Andrew Walker Exchange, you're probably not going to come trade on me, no matter how big the basis trade is because there's a lot of fraud risk there. Like, look at me wearing my pineapple shirt for those on YouTube. I'm the guy who's going to run with your Bitcoin, but you're doing things with real business. And, you know, yes, they could make a ton of money stealing the Bitcoin, but your first thing would be they're already making a ton of money. So why become a criminal when you're making tons of money on the exchange side would be one? And the number two would be because Bitcoin, you can see, it's a digital token and you can see

who has it kind of in real time. Every other exchange is going to look at those Bitcoin that they stole and say, we're not taking those Bitcoin that's dirty money. And the same where the U.S. government, if they can find like the, the government, if they can find like the guy who's stolen $5 million in sequential $100 bills, they try to track all of those the ID numbers or whatever. It's pretty tough if you're doing it one at a time. But in this case, because it's computers, they can do it. Am I thinking about that correctly? Yeah. There are companies like dark trace and chain analysis that specialize in blockchain audits like tracking stolen funds

across the internet. And there are like there are US like criminal cases right now around like some of the exchanges that were, you know, doing, that were really bad actors in the kind of 2012-13 period. We had a big explosion with Mount Cox, which was the big exchange at the time. No one really knows if the money was kind of lost or stolen. Big question marks there. And there were a bunch of other exchanges that were linked to Mount Cox. And this is all in litigation right now. And there are people in jail. So it's much, you know, there's really two things. Like the first is it would be economically irrational for one of the big exchanges to do this. It just doesn't make sense.

Like the founders are millionaires, I think. So, you know, why would they do it? It just seems like you're unnecessarily complicating your life. And the second is, well, even if you did do it, it's actually going to be really complicated to actually get away with that. So there's a little bit of a soft kind of comfort there. Let me turn to the next risk. And this relates to...

Well, let me just... Yeah, yeah, go ahead, please. Which is, there is the whole... There's a whole gamut of crypto exchanges from fully regulated, like, Coinbase and Cracken, like, based in the US, regulated, like, bona fide regulated exchanges, all the way through to, like,

the mom and pop shops. Like, you don't even know who the founder is is or where it's based. Like, there's no jurisdiction or anything like that. And so you can pick where to trade, and, you know, you can sort of, Pick your own risk appetite, if you will. And you can also spread your capital around.

So, like, we don't put more than X amount of our own capital in a single exchange. It's spread out. So even if what I think is a relative kind of tail risk were to happen, you know, if you lose, you know, in the worst case, what, 20% of your capital, but you're making 20, 30, 40% annualized, it's not the end of the world. It would suck. But it's not the end of the world. And this is the worst case scenario.

Yeah, yeah. Okay, that makes sense. Let me turn to... What's the second one? So this, it's a little bit looser. And we should probably talk the collateral risk at some point, though. I think that's a little bit simpler in people, you know, I think people understand how that works. But this relates, you know, I do worry about exchange blowup risk, right?

So forgetting fraud, a lot of these exchanges lend. lend up to 100 to 1. Now, I'm going to guess that you and most of your managers are not borrowing 100 to 1, but there are people lending to 100 to 1. And we've seen what happens, you know, when I wrote the original future arms, Archegos had just blown up. And that was 5 to 1 leverage. And I remember very well,

Forex firms, which let retail customers borrow 100 to 1, when there was a swift move that no one expected in the 4X world, not only do their customers blow up, but a bunch of 4X firms blew off. or had to get huge bailouts in order not to this thing. So when I see crypto, and this is kind of timely because we're talking Wednesday, May 19th, Bitcoin opened this morning at 44,000. It touched 30,000, six hours later, and now it's back up to 40,000.

So it is kind of in real time, we're seeing this, but I worry you have that cascading risk, right? Where a couple people borrowed 100 to 1, Bitcoin drops 2%. So they immediately get sold out in the exchange deal well there. But because they get sold out, Bitcoin drops another 1%, more people get sold out. and you go domino, domino, domino, domino. So, and if enough of those dominoes fall, you could have exchanges blowing up left and right. So how do you think about that risk?

Yeah, it's super timely, like you say. So we call that a liquidation cascade. So like one person getting liquidated triggers the next, the next, the next, the next, and you sort of have this chain. Unlike traditional markets, the exchanges are the clearinghouses pretty much. So the exchanges mediate between, you know, If we look at a perpetual contract, for example, but the futures work the same way, you have open interest. So, like, a contract is basically created and you have one exchange participant, like an exchange user, like David, is long a particular contract and Andrew is sitting on the other side of that short.

The exchange, you're not trading against the exchange like you would on a CFD platform, and there are also no clearinghouses or really prime brokers in our space. So what the exchanges role in all of this is basically to provide a matching engine and collateral management and liquidation management. And yeah, the exchanges offer on paper 100 to one leverage. The only way in hell you would ever do that is like creating 100 different sub accounts and putting like a hundredth of your capital on each of those subaccounts. Then waiting for an event like we had today where we had a huge kind of liquidation cascade, the market just destroyed downwards and then bounced. You get these kind of sharp reversals on the other side of it. As, you know, once the liquidity is totally unwound, you get a strong bid under these.

And you can imagine having like 100 different self accounts and going like 100 to one leverage on each of those at like one second increments around the time when you think the market's going to reverse. And if one or two of those accounts end up, like, bottom ticking it, you're going to make a ton of money in that. So, like, that's the only example I've ever thought of where you would actually want to use 100 to one leverage in a kind of professional sense. But 99.9% of the time, people are, you know, using 1x, 2x, 3x max. It's, there's really, in an asset class that has a all of 100, you really don't need to use leverage. It's more about, you know, if we're trading something with 3x leverage, it's usually because we feel very comfortable that we can margin

that position, no matter, pretty much no matter what happens in the market. And in exchange for taking on, you know, a real, real kind of tail risk of, you know, the market moving so hard, so quickly that we're not able to margin the position, we get to keep two-thirds of our capital off the exchange. And so, you know, we're reducing by a really significant factor our counterparty risk, coming back to kind of that being the big, the big issue of these trades. So we will often run a, like a short basis position or like funding rate trade at 2x leverage in terms of the equity at the exchange. But we are holding cash. at the ready, or specifically Bitcoin at the ready, that we can move in in like 10, 15 minutes

onto the exchange to margin that position if we ever need to. So from your, and we'll have to go back to the exchange, but this is super interesting me. So from you as a, you know, fund manager, like a retail investor is going to look at it and maybe even a simpleton like me is going to look at it and say, oh, you know, margin is to enhance the upside and the downside, right? And I go on to whoever I'm going to say again. I mean, it is, but that's not what most people are using it for.

But, but, you know, a lot of retailers would go on. They'll put $50 down. They'll use that to buy $100 worth of Bitcoin, right? What you would do actually is if you had $100 because you're worried about this exchange risk for a lot of your funds, you might only put, if you had $100 in equity, you'll put $25 on to the exchange. You'll buy $50 worth of Bitcoin or, you know, do a lot of other complicated trades and stuff. Exactly. But that way, even if the exchange turned out to be fraudulent, you've only risked 25% of your capital. So you're using leverage to manage your counterparty risk.

That's super interesting. Yeah. Did you want to say anything else on the cascading risk? Because I know you've also talked to me offline about how the exchanges can manage their liquidation and cascading risks with their customers. Yeah. Talk about that a little bit. So, yeah, coming, you know, coming back to, you know, the exchange basically sits in the middle and the job of the exchange is to like match trades and make sure that both sides of the trade are always solvent. And they are absolutely savage at kind of managing that. So, like, the way the contracts work is, like, the exchange will mark the contract at, you know, a price that they say reflects the amount of slippage involved in closing out your position, but really, they'll mark the position to whatever they want to market up. And they can do, you know, they can do this extremely aggressively. And so, you know, whenever you're close to getting liquidated, you should be really worried because the exchange

exchanges historically have exercised a lot of discretion around this, and they've been brutal. Like, people, so what you'll see in a move like today's, where, you know, so far we've had three kind of distinct large liquidation cascades where a bunch of people got wiped out for a total of about $4 billion notional across Bitcoin and E. Like, the longs will basically just get absolutely kind of, sorry. Absolutely, kind of possession is just taken over and forced liquidated in a move like this because the exchange is just not willing to take any risk that they're going to not be able to close out the position of the profit. And so the first thing is like the exchange will quote unquote auto delverage you.

So like take over your positions and liquidate them forcefully into the market. it. Because it's the exchange, I can't, I can't confirm it, but I am guessing that they're going to, you know, put the exchange, these ADL kind of orders at the front of the queue. So they'll, you know, privilege, like, deleveraging transactions, or orders in the order book before everyone else's, because it's the exchange and they can. And they're just savage at kind of protecting themselves. The next is sort of the next kind of rung down of redundancy is, is, well, you know, maybe they didn't manage to close out the position in time. And so they liquidated the position, but the, you know, the long was a negative equity. And so what happens to the short on the other side of that trade? They've got what's known as an insurance fund where it's basically an on-balance sheet pool of capital that builds up over time because they either top it up out of their in fees, but more specifically, they, every time they auto-de-leverage someone, they take like

a 1%, 2%, 5%, whatever it is, kind of penalty fee on that. So they'll take over your positions, they'll liquidate you, they'll take 5%, put it in the insurance fund and give you whatever's left over, if anything. And they'll dip into this insurance fund in the case of like an insolvency to pay out the other side. And these like insurance fund are, you know, every exchanges website discloses it publicly it's there is a risk that they're making it up because it's typically not audited depends on the exchange but on the sort of like you know unregulated offshore exchanges you're kind of taking them at that word but you can see it looks like a market maker in terms of the kind of P&L of that insurance fund like it drifts upwards all the time and then in an

event like today it'll just kind of dip down as they're kind of dipping into their insurance fund to pay people out, and then it'll kind of resume its trajectory upwards. And these insurance funds are huge today. But I'm guessing they're keeping all of their insurance fund in cryptocurrency? So they, it depends. So on a linear perpetual contract where the margin is in dollars, they'll keep it in dollars, but more specifically in a stable coin. So most of the perpetuals margined in USDT, like Tether, and so they'll keep the margin in that, in USDT. And then for the inverse contracts, like a Bitcoin margin, Bitcoin USD perpetual, they'll be keeping in Bitcoin.

So they do like match that kind of asset and liability there. Yeah. And this actually leads to one of the risks. Go, go, go, go. Yeah. So the risk is like, if you are, let's say you are trading like a, perpetual based on ripple. Ripple is like an asset that, you know, it's, it rips up, it rips down.

It's, I think, basically like a fraud, at least a marketing fraud, like totally worthless, like complete speculative kind of, it looks like Dogecoin. Let's use Dogecoin as the example. Yeah, I'm just going to disclose that all of those were David's opinion. None of that was a statement of fact. That was all opinion. Nobody should lie on anything he just said. I'm not saying it's not a.

very informed opinion, but it's definitely an opinion. It's an opinion. Let's switch to Dogecoin. Like, Dogecoin was created by a guy who just copy-pasted Bitcoin and put a Shebrino on it and said, this is a joke. And this is my way of, you know, showing the world that, you know, Bitcoin is worth nothing because you can just fork it and create a new Bitcoin, in this case, Dogecoin. And look how stupid, like, Bitcoin is as an experiment. like it's explicitly a joke and the guy sold out of it like it's it's a defunct project that just sort of exists and it's you know crazy and hilarious what's happened well hopefully as long as no one gets hot it's hilarious it's the only legal tender it's going to be the only legal tender

accepted on Mars let's not get into that but so dogecoin goes up and down like super super volatile, okay? The way the, there's two ways of trading that with leverage. And let's just look at the perpetuals. One of them is to buy like a Dogecoin, a linear Dogecoin contract. So the margin is in dollars and you're getting like Dogecoin dollar exposure. In that case, the, if that contract kind of blows up, if there's a, an insolvency, the interest, insurance pool is the actual like USD insurance pool that the exchange has, which is spread out across a bunch of different assets. So every perpetual that is margined in in USD, more specifically typically USDT, is going to have that one insurance fund. So you've got a bunch of different like

pairs that are USDT denominated and margined, which all share in one USDT pool. Then you've got like the coin margin contracts, which are inverse. So post Dogecoin as collateral and get DogeCon USDA exposure. And there are kind of risks and rewards to both of these things. If we look at the USDT margined contracts, if Dogecoin goes to the moon and you're short, you're going to have to post more and more and more dollars to margin that contract, like an infinite amount. Like Dogecoin went up, what, 24,000 percent? Like imagine that just eating through all of your capital and then ultimately blowing you out. You can't take that risk.

So many people wanted to sell GameStop, just to bring it back to the stock market, which is what I have to see. So many people wanted to sell GameStop calls or GameStop was at 300. They wanted to short it. And I know a lot of people who were taking victory laps. They were like, GameStop went from 300 to 200 to 200.

It's great. And I was like, what world are you living in? This is the worst trade. I know people who want to short Bitcoin, who want a short like scam cryptocurrency. And I'm like, this is the worst trade you can possibly imagine. The best you can do is make 100%. and the worst you can do is have GameStop squeeze up 4x, your margin is going to go up 100x.

They're going to liquidate your entire fund in point-blank time. It's the same for shorting Dogecoin or any of these joke things. Anyway, again, nothing's investment advice, but I would never, ever, ever recommend anyone shorting anything like this. Yeah, you could almost say that is investment advice. Just be careful. I'm pretty sure for legal reasons, I cannot. But, look, shorting anything is, you might think it's very easy. It is the riskiest thing you can do.

And everyone, again, not a vestibite, but just don't short, don't short thinly traded scam coins. Like, what's going on? Anyway, please continue. It's already going on. So on your dollar margin contract, like, if you were to go short doge coin, you'd better be ready to post infinite margin. So that sucks.

So you don't want to do that. So the other way that you could do it is on an inverse contract. where you're margining in Dogecoin and you're shorting the Dogecoin perpetual, you would do that because everyone else wants to go along the Dogecoin perpetual, because obviously it's going to the moon. And so the perpetual is trading at a premium, and you can collect that funding rate, which is equivalent to your basis in the future. Okay.

Now, the benefit of a coin margin contract is that if Dogecoin does go to the moon, your short perpetual position is going to go, like, deeply in the red, obviously. but the collateral you've posted against it is going to be going up at the same time. So if Dogecoin goes to the moon, you still stay fully collateralized. So you can take one Dogecoin posted as collateral and sell one like one Dogecoin's worth of perpetual against that and you're fully kind of delta neutral and you'll be hedged on the way up and on the way down because your collateral is going to move with it. You're describing an arbitrage, right?

This only works as an arbitrage. This is an arbitrage trade. Yeah, yeah, yeah. The problem that you face on the coin margin contract, because there's no free lunch, is the insurance fund behind that contract is going to be Dogecoin only. And because the asset is so volatile and thinly traded, it happens frequently that people get liquidated and that that happens at negative equity. So the exchange is having to dip into the insurance fund more than, say,

the Bitcoin fund, which has much lower volatility and much more liquidity. And so the insurance fund, like the Dogecoin insurance fund for the coin margin dogecoin perpetual, are you following? My head's swimming a little bit. Yeah, I'm 90% there. My head's swimming a little bit, but I'm 90% there. So like, let me skip that. Basically, like, the risk that you have is that the insurance fund on the coin margin contract,

while it's better to trade the coin margin contract, because you take away. this risk of Dogecoin going to the moon and you having to post lots of lots more dollars to margin up, that's the good thing. The bad thing is the insurance fund is really small and it can easily blow up. And the exchange does not care about the Dogecoin perpetual contract. It's not strategic to the exchange. So they don't care if it blows up. They care a lot if that Bitcoin or Ethereum contracts blow up. So we would not, for example, short a, we would not put an arbitrage trade on like a doge coin basis trade, even though the basis was like 200% at one point.

It was insane. It's just too risky. So what you're saying, you would do it on Bitcoin or Etherin because even if the insurance fund ran out, the exchanges would make a tactical decision and say, look, if we let the Bitcoin contract, the Bitcoin contract, uh, kind of died because our insurance contract, we've destroyed our business. So they will make a tactical decision. Maybe we chip in a couple million dollars of cold hard cash to keep this contract afloat because doing that protects our literal multi-billion dollar business. And if we don't, we've destroyed it. Am I saying that correct? So the, yeah, the first thing is like the

insurance funds for those contracts are enormous and much larger, even on a relative basis, like the open interest in the contract versus the insurance fund is high. And kind of battle tested and these markets are much more liquid. And then even if the insurance fund got blown through, these are strategic contracts to the exchange. They're going to do everything that they can to save them, which I don't think is true of a like Dogecoin contract. Let me make two quick points. And then I want to flip, I kind of move on from this and talk about some other stuff in the crypto world. My first point would be, I guess, you know, look, stock exchanges operate, you know, five days a week, eight hours a day. So you can have this stock, you know, closes. You've got a little,

someone's lent some margin against it. Stock announced awful news. Stock opens up down 80% the next day and they've gone through all the margin and all the loans. So the guy's taken, I guess with your exchanges, A, because they're open 24-7 and B, because they're used to how volatile Bitcoin is,

whereas with the Forex stuff I mentioned earlier, the Swiss currency would only move one or two percent a month at the time. So when it drops 10% in a second, but because Bitcoin 24-7 and because they're used to volatility, they're probably better equipped to actually avoid the liquidation scenario. Am I saying that

correctly? Yeah, I think, you know, March 2020 was about as violent a move as anyone has seen in a very long time. But if you think of the craziness that you saw in like equities and fixed income markets, like crypto trades with a lot more volatility. So like four or five X the craziness and that's what was happening in our market. Ultimately, how much was Bitcoin down March 2020? I think it fell like 45% in a couple hours at one point. You just had a straight line down. But broadly we went from about 10K to 3.5K.

Great. And we came into that period with a lot of leverage in the system already. But no one bailed the crypto market out. And it cleared. And I think it's a real testament to what these experiments. exchanges have built, aside from all the other kind of mud you can throw with them, it's pretty impressive that these markets cleared during that insane period of stress. And a bunch of traders got carried out on their backs. All sorts of like shenanigans and stuff happened. But ultimately,

like the markets cleared. No contracts blew up. No exchange blew up. And all of this happened without a bailout. And that was a really, you know, things have only gotten better since then. Like insurance funds have gotten bigger. The exchanges invested heavily in infrastructure. We see less outages. We see less like API overloads, matching edge and overloads. Things are generally, you know, trending in the right direction since then. And if March 2020 had happened in 2018 or 2019, I think the whole market would have just collapsed. So it's a recent, phenomenon that things have gotten better. And I'm guessing so much attention and money has poured into the space since then that,

you know, the system today, we're only 15 months removed from that. But the system today is probably exponentially better than it was in 2020. Would that be right? I think it's certainly more robust than it was. Let's move on from this because I do have more questions on to this, but let's talk about some other stuff. I think we've hit, you know, 80-20 rule. I think we've hit a lot of interesting things there.

One of the questions I got online that I think you were jazz about was, what are your thoughts on buying crypto versus buying miners? Why don't we talk about that for a second? First, can you explain buying crypto versus buying miners? And then what are your thoughts on that are? So, yeah, let's just talk about like Bitcoin and Ethereum mining. For a long time, there's been. just a general kind of trope, I think, among, like, the crypto tourists, like, investors that are not

in the space full time that start looking at it and say, well, what investment should I make? There's this allure to mining, which is basically, like, I can buy, like, these crypto mining rigs, which are, like, basically, like, computer chips, and you plug them in, and they run these, like, math calculations, they try and factor really big numbers, and if they factor it faster than anyone else, then they will win basically a bunch of Bitcoin. And this is a process that happens every time a new batch of transactions is processed in Bitcoin. And so it happens every 10 minutes. And like basically you can, you know, you can write a pretty simple equation of like chips and electricity in, Bitcoin out. And then I can take the Bitcoin and I can sell it. And so

it's sort of an equity like cash flow like business to operate. And so there's been a lot of interest from people in Bitcoin mining. Like, wow, this is great. The problem with mining, and let's stick with Bitcoin for now. Yep, yep. Is that, like, Bitcoin is basically, it's a protocol. Like, this is open source code. And so you can go in, the whole thing is deterministic.

So you can go and look at, like, the underlying code and say, okay, like, how do miners get paid out? And, like, what is the kind of effectively, like, the pricing dynamic underlying matters. And what you find is, like, Bitcoin is explicitly structured in such a way that if more miners come in mine and the, what's known at the hash power, like, the aggregate computing power being applied, goes up. The difficulty goes up. And the difficulty is specifically, like, how difficult is it to, like, factor these numbers and get, get, like, rewarded this, like, fixed amount of Bitcoin. Yep. And so if you have, like,

What people don't, where I think people's heads kind of explode with crypto mining is if you take a copper mine or a gold mining today, like there's a cost of extraction which is basically fixed. And if you're willing to spend on the capital and on the like operating expenses, you can go and you can extract that gold for X amount of dollars. And so like the more capital is applied to the space, the more supply of gold comes out the ground. In crypto, the supply of Bitcoin is monotonic. There is, at the moment, six and a half Bitcoin basically 6.25, like produced and given out as a reward every 10 minutes. And that is irrespective of how many miners are trying to mine. So if there's one guy with his laptop, it's still going to be

six and a half. And if there's like thousands upon thousands of people with like billions of dollars worth of like specialized computer chips that have been bought and are only doing this, which is the case today, it's still 6.25. And so to bring it back to why I think mining sucks, like that equation basically says that the average miner is going to be pushed down to the marginal cost of production. See, this is great. Can I kind of add on here and get your feedback on?

So the most popular pitch I've had, every single investment bank that I've already has come to me recently with, hey, we've got this guy, they've got advantage to access to power in some form. You know, sometimes it's, they've got, you know, they're a little bit closer to the sun, so the solar rays will get them, or they've got this decommission power plant. They've got all these pitches. And they say, hey, we can go do this, lend us $200 million in convertible debt.

Our break even on Bitcoin is $3,000. We're going to do this and we're going to make a portion. And my pushback has always been, and I've known I've been a little bit off. But as you say it, I think this is right. My pushback has always been. The reason this is profitable is because Bitcoin's gone up 10x in the past year. And there haven't been enough people who've been able to build. these things. But what's going to happen is you're going to have everybody is making the same

pitch at the exact same time in six months, a year, 18 months, whenever it is, there's going to be 10x the computing power trying to do this and exactly what you're saying is going to happen, right? Like, it's the amount of computational power is going to go up exponentially and you're not going to make as much on Bitcoin because so many people are pursuing the same arbitrage strategy. Did I say anything wrong? Would you push back? Would you agree with me? What do you think? I think like you're direction you're right. But like the difficulty gets adjusted every two weeks. And the hardware basically depreciates on a two-year time horizon. Yep. Because the chips keep getting better. I don't know how long we have to really go into this,

but we definitely can. I think it's an interesting one. Maybe we can cut it. I do think we're kind of running up on the time. But this, I've got a couple of questions. Let's try it. We can have you back on unlimited amounts of time to talk about that pollution. Because the cool thing is, look, if you came back six months from now, we could probably still talk about digital mining, also probably talk about 15 new different alt coins coming up. We probably can't talk about Com Rocket because we got to be kid friendly or something. But there'll be new alt coins. There'll be new things we can talk about. That's what's so cool about this space. And I'm going to learn about it. But please continue on the mining. Okay. So the mining, like the key thing

I said when I was poo-pooing this is like the average miner is going to be pushed to like zero profit. If you can mine more efficiently than the next guy, then yeah, you can extract a profit there because you just need to be better than average. The issue is like because of, it's a whole thing, but like Bitcoin mining has moved from doing it on your CPU to your GPU to a type chip called FPGAs, and we've moved from that to ASICs. And ASICs are application specific integrated circuits. It's a type of chip that is hyper simplified to do one single type of operation, which is factoring, these numbers, like just Bitcoin mining, it's the only thing it does. The way chip design and manufacturing works is the more you can narrow down the scope of mathematical operations

a chip needs to do, the more efficient that chip can become. So a CPU is like the work course of your computer, it does a bunch of different things, and therefore they're not very kind of efficient because they need to be able to do a lot of things well, like quite well. An ASIC chip is like hyper-specialized and does that one thing insanely well. And so the dynamics around like ASIC production are extremely high kind of upfront cost, sunk cost, and then the cost of actually producing them is very low. And this basically consolidates the market

into like one, two, maybe three producers who effectively are like competing, like in video is competing against the other manufacturers, like doing something that pretty much is equal to what the next guy is doing. And so what this translates to from the miners perspective is, like, everyone is buying the same chips. And the only other variable that you have is the cost of electricity. Yep, yep.

Right? And so you've got these like U.S. mining operations going out and raising capital. And they're saying, hey, you know, we've got a low cost of capital, low cost of electricity, you know, we're basically better than average. And that's what's going to allow us to produce Bitcoin below, you know, above. produce Bitcoin below the average cost and therefore make a profit. The issue is like you're basically competing against people in China or Kazakhstan or wherever it is that are maybe bribing the power station guy and getting electricity for free or going to a stranded asset, which, you know, certain types of power like nuclear, you can't just

switch them off. And there are, there are, I'm not the expert on this, but like from people I've spoken to, like, there are places in the world where people are generating power in excess of what's being consumed, and they actually have to pay to get rid of this power. Yes. So it's possible to have a negative cost of electricity. I think hydro this can happen. So you could imagine, like, you're competing against people who are either doing like shady stuff

that you can't compete with or like, you know, things where like potentially are getting paid to take electricity. Like, it's just a game that I don't think is really worth playing. And to your second point, which is, well, isn't a big part of the profit of these miners is just the beta. Like, they produce the Bitcoin, then they hold the Bitcoin and the Bitcoin goes up. So if you're looking at a mining, you really need to strip out like the appreciation of the Bitcoin that they've huddled. And if you do that, it looks like a much less interesting business. I hear you.

My point was more like the reason that mining's profitable right now is because Bitcoin has gone up so much and people haven't been able to get enough computers on to take advantage of that, right? So in six months, if Bitcoin's still at 40,000, like, so much money's pouring into the space, there's going to be 10x the computational power. So that's kind of more what I was saying. I'm with you, though. I think in the long run, you know, at some point, if Bitcoin is the future, all of the mining, because there's no advantage on chips, chips, right? The chips can be anywhere. All of the mining will be done wherever the cheapest place to generate electricity is. That's probably like really, you know, Saudi Arabia makes the most oil because they've got these huge,

really easy to extract oil fields. If you're thinking Bitcoin, the future is probably, you need a constant supply of power so you're always mining. So it's places located next to Hydro. Maybe it's a solar farm in the Sahara. But it's probably geothermal. Well, yeah. It's probably great hydro or if there's really good battery technology, you could imagine

solar. Like Texas has tons of solar, but you're totally right. Like, yeah, you want somewhere with 24-hour electricity. But I think the only advantage. is getting the cost of, giving the cheapest cost of electricity. So it's probably a place of really good natural research. Yeah. And by the way, you're probably also competing, like the chip manufacturer, you know, the top chip manufacturer in this space, like, they mine themselves. Yeah. So they're probably getting the next gen chips two, three months before everyone else's.

So it's, it's just a crappy game to be in, I think. There are better places for people's money. This is, that's where I've come out to. But, you know, the numbers, because they bring the decks to you and it looks so good. agrees with me though no i think i think i think i think the profits go to uh the chip man who's ever the cutting edge chip manufacturer but that's a very competitive business but you you probably do get whoever gets the lead can continually push that and then the profits go to whoever owns the land that has the best access to the electricity is would be yeah yeah my guess look david we have covered so much this has been super interesting you know let me ask you this one more question

and then i'll let you wrap it up you know obviously you're fun you're you're you look at both internally and externally at quants. I guess when you're doing this, the crypto space, it's been around for, you know, I'd say institutional trading on it's only three or four years old. So it's still pretty new. When you think about something that new, it does seem like you get a bull in a bear cycle like once a month. So maybe there's a little bit more data. But when you think about something that new, how do you just kind of, we don't have to talk about all the villages, but how do you think about evaluating potential managers with this kind of a new space? Yeah, like we don't have, every manager's emerging in our space

because the longest track you're really going to come across is like two years. Really high level, like, and you know, I have a little counter. Like, I'm on like 700 plus manager meetings at this point. And you start to be able to triangulate. And like really the number one thing we're looking for is, well, certainly like integrity. There's just no point working with a manager you don't feel comfortable with.

but the real runner-up to that is they need to be like genuinely world-class at whatever the strategy they're running and if you can talk to enough managers and really get kind of a cross-section of the market and see how deeply different people are thinking about things and start kind of, you'll always get an insight out of every good call with a manager

and you can apply that insight to the next call with a similar manager with a similar strategy and so it's kind of this like triangulating between who is world-class at this particular relative value or arbitrage play that we see in the market. So it's kind of like understand the crypto market as deeply as you can, then kind of drill in to the areas of opportunity that are undercompeted

and really have some fat on the bun, and then find like the top two or three traders in the world doing that and see if one of them will take your money is a simplified way of looking at it. Is there a typical, obviously you guys have lots of strategies and stuff, but is there a typical background that you're seeing a lot of successful crypto traders have? you know, I personally, in my head, I probably have like a quant trader background in my mind, but is there a typical background that you're seeing? Yeah, I mean, most of the good, most of the best people have come out of prop shops.

Like it's the Chicago prop shop trading scenes, like 2 Sigma, Wolverine. There's a lot of guys coming out of Optiva who've moved into crypto for whatever reason. XTX, Rentech, like the big kind of quaint shops where they've successfully traded extremely competitive markets. And then they move into crypto. Last question here. It's a 24-7 market, which is obviously different than, you know, stock exchange, bond, all that sort of stuff.

A manager can only be up for so long. And a lot of these, you know, prop trading is, it's a pretty active involved trading. I'm sure if they've got lots of computers, that's one thing. But when markets are really fluctuating, which happens, you probably need a human eye, just making sure the computer's not going crazy. How do they manage that kind of 24-7 risk? Yeah, it's tough. So, I mean, one of the things that we really drill in on, like, in excruciating detail with managers as part of our DD is, like, exactly they're monitoring and alerting and exactly how those work.

How exactly do you calculate a drawdown in your system and what happens when that alert's triggered and where are those set? And that's a big thing. We see managers, you know, as soon as they get big enough, they're trying to hire a second and a third kind of. trader just to sit on the screen. Yeah, yeah. So, you know, that fine will always be, you know, on. Like, they'll have like emergency contact for whoever's, you know, screen trading. And there's just someone monitoring 24-7 and so they'll see, like, a guy in the U.S., a guy in Europe and a guy in Asia, for example. I was about to make that point. I was going to say they got to hire someone in Europe and Asia and 24-7, cool. Well, David, we've covered so much. I just want to make sure,

was there any lingering thought in your mind that you wanted to have on. I mean, I'd love to have you on again in six months or so to talk about. Yeah. Whenever. There was. There's a lot we didn't cover. Well, as long as there's something that you're not thinking, like, oh, God, I wish I'd made that point. I can't believe I didn't get out there. But as long as they're not that, we can wrap it up here. I don't think so. Okay, great.

Quick questions. David, this was so much fun. Look, David, I will include a link. He did another podcast a week ago. I like to think this one went better. But I found him that very informative. So I included the link to David's other podcasts he did. If people want to hear more of David, I'll include a link to his Twitter.

If you want to find him, reach out to him anything. Obviously, I will also include a link to the article I mentioned on Bitcoin Future Arbs that I wrote, if anybody is interested in that. But, David, this has been so much fun. Thank you for talking to me earlier on this. Thank you for talking to me now on this. And we're going to have to have you on again and talk about how crypto is developing over the next six months. Thanks for having you on. Hey, have a good one, man.

You too.