The Exchanges

Q As the ecosystem has evolved, where do you find inefficiencies today?

A Frankly, almost everywhere outside of simple arbitrage. Bitcoin trading is, like in any asset class, large caps tend to be more efficient than small caps. That's definitely true in crypto. Bitcoin, you do have machine learning algos from guys like Two Sigma and Susquehanna pointed at it. So if you're just trying to do simple quant looking only at Bitcoin and price data, traditional quant where you look at basically volume and price is your two indicators, that is very competitive and very tough. But for example, not that many people do that and throw in the on-chain indicators. Amazing thing about cryptocurrency is that we have these whole new types of data that traditional quant has never had. And traditional quant firms have no idea how to make use of it. So the idea that we can see in real time, every single Bitcoin transaction that's happening is incredible. It's an incredible wealth of data. And so anything that uses on-chain data is still inefficient today. I think on the fundamental side, this is such a fast moving industry. We feel like we're barely keeping up with 10% of what's happening in the space. And we do this 18 hours a day with a team of six connected with everyone who matters in the industry. And so the way I think about markets as efficient is they're efficient if people like us make them efficient. They're efficient if professionals with sufficient capital a…

AI assessment note: “anything that uses on-chain data is still inefficient today.”

Q So across the assets you own, there's Bitcoin, Ethereum, you mentioned DeFi, there's a couple other areas that you could participate in. How do you map out the landscape in what your investable opportunities set us?

A Fairly simple in the sense that it's basically anything cryptocurrency related at the highest level, and the main limitation is liquidity, and from two angles, liquidity in terms of what can we trade into and out of, in that we have non-trivial assets. If something's a three million market cap, it's not really investable for us. And then secondly, liquidity from a liquid versus illiquid perspective is in privates investment. We're currently much more focused on the liquid side of things, and so when we invest in illiquid assets, and we do occasionally do equity Generally, we're looking for things that are going to have liquidity in one to two years. And so those are usually early stage projects that expect to list a token, because tokens can provide liquidity typically faster than equity. So those are really our only two constraints. Beyond that, we look at anything cryptocurrency related, and it's still a small world in the sense that everything touches on everything. And as an example, NFT projects, non-fungible tokens like digital art, digital collectibles, they're often storing the actual artwork On IPFS, which is a decentralized file storage system that has Filecoin associated with it. So you have this interaction between decentralized file storage, which is kind of its own sector, digital art, its own sector, and the NFT space, most of it sits on top of Ethereum and a com…

AI assessment note: “it's basically anything cryptocurrency related at the highest level, and the main limitation is liquidity”

Q So let's talk about alpha and beta. Beta, pretty clearly Bitcoin, maybe a little bit of Bitcoin and Ethereum. How do you think about the alpha opportunity of active management in this space?

A It's incredibly high, and that was part of my thesis looking at the space. It wasn't just the positive EV of the beta of Bitcoin. It was also, as a trader in a prior life, trading's hard now. Machine learning, algorithmic trading has eaten up a lot of the alpha that used to be discretionary. It's extremely competitive. Trading is just very, very competitive. Things that used to be incredibly easy to do now are eking out single digit returns where there used to be triple digit. So it's hard because it's competitive. It's hard because algos are in it. Lots of capital is in it. It's hard because there aren't barriers to entry. So in crypto, it's only barriers to entry. Everything is hard about crypto. You have the regulatory uncertainty around certain things. You have lack of trading software, lack of operational Tools. You don't have accounting software. You don't have back office equipment. You don't have a Bloomberg terminal. All the things that you take for granted in the traditional world, custody, reporting, tax filing, like everything, none of that existed in 2017 in the cryptocurrency world. The best you could do as a back office was a spreadsheet. There were some basic, basic software packages that would capture small fraction of assets and exchanges, but those ultimately had to feed into a spreadsheet if you were doing any diverse styles of trading. So all of that was op…

AI assessment note: “It's incredibly high, and that was part of my thesis looking at the space.”

Q So, 20 17 starts to play out. Bitcoin starts moving. And what was the key factor that led you to leave to start BlockTower?

A I felt this incredible sense of urgency that I had more conviction than I'd ever had in any trade that we were in the midst of a parabolic run. It just felt like it's happening. This is crossing the chasm. This is going from niche toy to mainstream. I was very confident that we were going to be getting in 2017 something like 10 X price appreciation. And so I felt this immense sense of urgency to capture that in some way. To me, it was like a clear opportunity of a lifetime. I'd spent hundreds of hours researching it. I felt like I had a deeper understanding of it than certainly most people in the world and most financial professionals, but it's not that often in life that you see an opportunity that large. And so I thought I have to seize this. I explored a little bit. Could I do that within the endowment world? Pretty clear that the answer to that was no. Even if I could convince you Chicago to make a small allocation, it would have been a small allocation, and it would have been spending a year getting them to put maybe fifty million dollars to test the waters. That wouldn't have moved the needle to the degree I wanted to. I was surveying the landscape on behalf of UChicago. I literally talked to every crypto fund I could find on UChicago's behalf, and there were like four that were investable at all. And by investable, I mean in the legal sense that actually had a hedge fund…

AI assessment note: “I felt this immense sense of urgency to capture that in some way.”

Q Over the last couple of years, what strategy or strategies did you pursue?

A I've always really valued the ability to be opportunistic. I think in traditional markets, I, along with most people, value specialization. When I was at U Chicago, if someone pitched us on being a global real estate fund, it was almost not credible because, wait, you're really going to tell me you're the world's best real estate investor in every locale? How? Unless you have a team of half a million people, how do you know the whole world's local real estate? So we always loved at UChicago hearing pitches from someone who only does Southern LA commercial real estate, because I believe you got a team of four guys. I believe you can be the best in the world at that. 20 block radius in crypto. I believe it's very strongly in 2017. The specialization did not make sense because it was a tiny industry with a small number of assets, a small number of key players, a small number of key developers and key technologies. And if you had expertise in those things, it didn't make sense to segment, for example, early from late stage. Because the difference often between early and late stage was one year. And so my view was you can't be a late stage crypto investor without having an eye on the upcoming stuff, because that's the stuff that's going to be competing with your assets in six months. And you can't be an early stage investor without the really understanding the incumbents. So I felt …

AI assessment note: “the ability to be opportunistic and not be handcuffed to a mandate was very important”

Q What teaching from your parents has most stayed with you?

A I've learned a huge amount from my parents and look up to both of them. One line from my father that I'll highlight, a lot of life is timing, and a lot of the reason Blocktower is where it is today is because Matthew and I acted with alacrity when we did. My father, in early 2017, I was talking, I had been talking about cryptocurrency for a couple of years, He was a good sounding board. He was interested. Didn't really have an opinion on it, but was just interested. And in early 2017, I started talking to him about how do I make this a career? And I think it was maybe in February when I said, you know, I think I could do this and start building a track record and maybe this. And at one point he turned to me and said, what are you waiting for? If you're this convicted and this passionate about it and you want to make this your career, What are you waiting for? And that one line, basically that day I started making concrete plans to leave UChicago and do something. I think my parents are pretty typical parents in the sense that they're a little bit risk averse when it comes to me at least, but hearing that from them, hearing that level of support and that something my father's always drilled into me is always keep your options open. I'd say he's a little bit on the conservative side and risk-taking just in the sense of maintaining optionality, but then he's always been someone wh…

AI assessment note: “One line from my father that I'll highlight... what are you waiting for?”

Q So how long did you stay at Susquehanna?

A I was there for four years, so it was a decent amount of time there. Trading was a very natural fit, a very natural extension of poker. I will say fairly early on, I realized that I didn't permanently want to be a trader. When the financial crisis hit, I was enthralled and fascinated by it. It was a moment of realization that Susquehanna really drilled in us this idea that we're smart young kids, Who don't know much about the assets we're trading and humility is the most important thing. And it's funny talking about traders and humility because traders by nature, you almost have to be a little bit arrogant to be a 24 year old swinging tens of billions of dollars. There's kind of a natural arrogance there, but Susquehanna, the whole thing as a market maker is there's always someone who knows more than you always. And your goal as a market maker is basically no one to get out of the way. If someone is willing to bet a billion dollars that you're wrong, it doesn't matter how good your model is. They might know something. And my favorite example of this, I traded crude oil futures at one point and There were terrorists in Nigeria who would occasionally bid up crude oil and then blow up a pipeline. So however confident I am in the fair price of crude, it may be that the person betting against me is literally about to blow up a pipeline. They have better information than I do. That's…

AI assessment note: “I was there for four years, so it was a decent amount of time”

Q And what do you see as the major risks?

A I literally spend more than half my time thinking about the risk side of things because I'm so confident in the beta and in the short-term alpha that literally Something I say to my team constantly is rule number one, two, and three, or don't blow up. Basically, if we can stay in the game and maintain our capital, and we shouldn't care at all about missed opportunities, because this is an industry and a market that generate amazing opportunities every couple months. If we miss one theme, forget it, don't chase it, don't sweat it. So I think about this a lot. Okay, now let me give you the real answer. Let me separate two types of risks. There's what I think of as market risks, where a catalyst could cause a sharp market sell-off, but it's temporary in nature. So we think of those risks from the trading side. So most regulatory risks are trading risks for us in the sense that, for example, BitMEX, which had the largest trading volume for Bitcoin in the world, they had 70% of all volume about a year ago. Their principles were indicted by the US government, and that could have been a calamitous thing for crypto markets. Bitcoin sold off something like six percent on the news. It made new local highs a few days later. That was an incredible bullish sign. Basically, this bull market was kicked off by The worst news many people could imagine happening, which was BitMEX getting indicte…

AI assessment note: “Let me separate two types of risks. There's what I think of as market risks”

Q So one last question before we turn to a couple of closing questions, which is if we look out five years from now, what do you think the institutional landscape looks like in this ecosystem?

A It's an interesting question. I think we've had recently people like JP Morgan say they think that in five years, Bitcoin will be integrated into the global financial system, which is kind of an incredible statement coming from where we were a few years ago. Right now, it's certainly not. I'd say the thing that the industry is racing to build right now that's the biggest pain point is a lack of prime brokerage, and a lot of the trading opportunities arise from that. So for example, basis, you can capture CME futures, often trade at a 20% annualized premium to spot Bitcoin. That's an arbitrage. Presumably, we think the CME has no counterparty risk, so it's an arbitrage. Well, why is it that high? The reason is just capital requirements because you can't collateralize a short futures position with Bitcoin. You need to use cash. It's an extremely capital inefficient trade. Now, if you could collateralize that futures position with Bitcoin, it would immediately be arbitraged away. It's as much an arbitrage as almost anything in finance. So basically there's counterparty risk in almost everything you do in the crypto world. There's smart contract and engineering risk in almost everything we do. That is a huge pain point. What I expect it to look like is All of the traditional prime brokerage bells and whistles and features will exist for crypto, and we'll have the start of crypto na…

AI assessment note: “What I expect it to look like is All of the traditional prime brokerage bells”

Q Alongside of your interest in trying to educate the people at Chicago, Bitcoin, I know you spent a lot of time on the risk side. And I'm curious, before we kind of dive into the crypto ecosystem, what did you learn about risk in a pool of capital like that?

A I'm a geek about risk. I'm not really a quant, but I've played that role to some degree at UChicago. My title at UChicago was portfolio manager and risk specialist. And my view on risk has always been that Risk is inseparable from return, that the idea of segregating the risk function from portfolio management is nonsensical. There's actually a discussion that I sometimes have with prospective investors in BlockTower, where they'll say, oh, do you have a separate risk manager? And my view is that you can have a junior risk manager, which basically just means a quant. It's a quantitative analyst who runs data for you and presents them to the portfolio manager. That's great. But the idea of having a separate person be the risk manager who isn't the most senior investment professional Makes no sense to me because that's the single most important thing. So my view is that risk management and portfolio management are truly inseparable, but you want the most senior, most talented investment professional to be running risk in basically any book. So Bitcoin, not that much has changed in five years. It is a mature asset. It is a little bit less volatile. It is still a young, hyper-volatile, hyper-risky asset. My view from the beginning is the realized volatility is very high. The forward-looking volatility is very high. There's also existential risk. This is maybe debatable today, but I…

AI assessment note: “Risk is inseparable from return, that the idea of segregating the risk function”

Q When you put all this together, what does the structure of your portfolio look like?

A We structure a portfolio that is trying to optimize between risk and reward in kind of a steady state, and then we're trading actively around that. I'll use today as the example. So today I believe we're in a bull market. I think we're in something like the bottom of the seventh inning, measured from the bottom of the bear market. So Bitcoin hit its lows of a little over 3000 dollars December, 2018. We've now gone from just over 3000 dollars to we hit a high of 58,500. Retail started getting into this market only this year in 2021. So I think we still have a ways to go. We're still seeing institutional spread. We're still seeing retail come in. I think we have substantial appreciation ahead of us, but we are starting to get into that last third of the bull run. So given that high level macro view, that kind of market cycle framework, I want to be playing things from the bullish side, aggressively from the bullish side. I want to be giving my portfolio asymmetry, upside skew. You can think of it like, I want my portfolio to look a little bit like a cult. And what I mean by that is, if I'm right on where we are in the market cycle, I expect all coins to outperform Bitcoin over the remainder of the market. With that said, all coins are riskier than Bitcoin. And if I'm wrong, and Bitcoin, let's say the top's in, and Bitcoin's going to correct 70 to 80%, Well, all coins will probabl…

AI assessment note: “currently our portfolio is all coin dominated. We manage risk more with cash.”

Q When you talk to your old colleagues at Chicago and other institutions, where have they evolved in their participation and thinking over the last couple of years?

A I'm not a great authority on the current state of UChicago. I don't want to represent myself as anything in that. What I can say generally about the endowment world is most of the top 10 endowments have invested in crypto funds. It's been reported, but I have no first-hand knowledge of this, that three of the largest endowments have directly bought Bitcoin. I think the cat's out of the bag in the sense that they all now feel comfortable in crypto funds, whether I think it's an extra leap to feel comfortable with direct ownership. But my guess is that in another year, that's similarly will feel not like a terribly difficult allocation decision operationally. In other words, do you want exposure to Bitcoin or not is an investment question. Are you able as an endowment to invest and meet your fiduciary obligations? That's an operational question. And I think the operational question is solved for funds close to solve for direct buying.

AI assessment note: “most of the top 10 endowments have invested in crypto funds”