Talk Your Book: Bitcoin Flows

0:00Today's Animal Spirits Talk Your Book is brought to you by Franklin Templeton Digital Assets. Go to FranklTempleton.com to learn more.

0:34in this podcast.

0:38Welcome to Animal Spirits with Michael and Ben. Michael, we were having some crypto conversations when I was visiting you in New York. And I feel like with traditional finance people, it always boils down to, especially anyone who's skeptical, it's like, okay, fine, the prices have gone up. What's the use case? Give me the use case now. Everyone is just wanting it. And it does seem like people in crypto have kind of just at this point said, well, the liquidity and the speculation and the number go up, that's going to keep people in until there is a use case. And we're fine with that. Is that fair?

1:16That is fair. That is a use case. It's a global barometer for risk appetite. We saw that over the weekend. We're recording this on Friday, April 19th. I know this isn't coming out for a few weeks. And what I've said earlier is it works. And what if that's it? And now, of course, that's probably not going to be enough for crypto dominance, right? Or whatever sort of end state these people have in mind. But for right now, new blocks, your own money, portable, self-sovereign, all that stuff, that's what it does. And it does exactly that. It is like the one 24-7 market that can be used to gauge things that happen off hours, whether the, and sometimes that is helpful in determining how the market's going to react.

2:01And sometimes it's unhelpful because it's a, it's a big overreaction and then cool, calmer heads prevail eventually. But having that, that one market until maybe we have other stuff that trades 24 seven, uh, you know, with more liquidity. But I think it is interesting as, as that risk sentiment gauge. It's like a, it's like a, the VIX for the weekend. Yeah, that's true. Bitcoin or crypto is a VIX, just on steroids. Okay, so I don't think we solved the use case problem. We've heard some good theories recently. I think we talked about some of them on this actual episode. So we had Christopher Jensen, who is the Director of Digital Assets Research for Franklin Templeton and their digital asset investment group.

2:44So we get into a lot of that. We define what store value is once and for all, which I guess we've never really talked about. So here's our talk with Christopher Jensen from Franklin's Digital Asset Investment Strategies Group.

2:59We're joined today by Christopher Jensen. Christopher is the Director of Digital Assets Research for Franklin's Digital Asset Investment Strategies Group and co-lead of the Digital Asset Investment Strategy Investment Committee. Christopher, welcome to the show. Thanks. Thanks for having me. Whenever I speak with people like you, and I don't mean bald people because I'm one of those two, I'm always curious, how did you go from a traditional finance background into the world of digital assets? Sure. So I've always been kind of doing the funkier things within finance, almost two decades of experience on the buy side, principal investing with a focus on alternatives and private credit.

3:39And when I came to Franklin in 2015, started doing credit, but immediately found and teamed up with a couple of gentlemen there who were, I think, doing some of the most innovative things at the firm. And that was kind of at that intersection of technology and finance. And so originally we were using machine learning models to underwrite little units of risk coming off of fintech platforms. And this eventually kind of, you know, I think if you keep following the tip of the spear at technology and finance, it eventually takes you to crypto, right? And I had dabbled in the space as early as, you know, January 2018.

4:17So it was on my radar, personally. And then, you know, professionally, as we started to get more and more into the esoteric sides of investing and the innovative sides at Franklin, we started to build out this digital assets group. So, you know, I think professionally speaking, been doing it since, you know, I think as a firm, you know, over the last five years or so, and even longer than that on the personal side. Does it ever surprise you that we literally created a new asset class out of thin air? I remember having a conversation very early in my career before Bitcoin was even a thing and people, someone asked a question at a conference or something like, is it possible to have, you know, additional asset classes?

4:56And the guy in state said, no, everything is basically just going to be a derivative of what already exists. And crypto in a lot of ways is something new and it's still relatively new, obviously. But to me, thinking through that from a TradFi lens, it is kind of bizarre that we literally created an asset class. Yeah, definitely. And I think that's one of the reasons why Franklin initially got involved, right? I think there's two things happening here. You have the technology, right? A blockchain technology and everything that's happening there and the way it's evolving. Things like the internet or financial system.

5:31And so, you know, from almost a defensive reason, I think Franklin was interested in, hey, this looks like a disruptive piece of technology. It can probably, you know, disrupt the asset management industry. Let's understand it. Let's get out in front of it. And that's why, you know, to this day, we're builders in this space. But then at the same time, on the other end of the spectrum, we realized it's not just a technology. It's creating a new asset class. and clients are going to be interested in what does that asset class do to a diversified portfolio? And then so we need a view on that. And so it's kind of always this two-pronged approach, building in the space, investing in the space, realizing it's both a technology and an asset class.

6:11That's kind of how we've approached it from the beginning. A two-part question. Were you surprised in November of 2022 when the FTX fraud came to light and Bitcoin didn't go down further than it did? I think it bottomed out at around 15 ,000, whereas in the previous cycle low, like in March 2020, it got under 4 ,000. And the second part of this way too long of a question is, are you surprised that not even, man, not even two years later, we made an all-time high when it seemed like this thing was just totally left for dead? Yeah, I think with respect to the drawdown, I think as the asset class matures and as Bitcoin, the leader of this asset class, matures, I think we will see volatility come down a little bit.

7:07And if you look at, say, the drawdown of Amazon each time since its IPO, and then each time was a little less, right? And so I think you see that with Bitcoin. And as the entire asset class matures, I think the volatility will come down and the drawdowns will be less severe. The fact that we're making new all-time highs just a couple of years later is pretty remarkable. But at the same time, you do have some shifts in the market structure, obviously with the ETPs and new ways to access the asset class, the democratization of the asset class, new flows, new entrants is a big deal. On the innovation side, we're seeing the innovation pipeline for digital assets, for crypto and blockchain technology is as robust as it's ever been.

7:58And I think this asset class tends to attract global liquidity. And as you're starting to see liquidity bottom and liquidity start to now kind of tick up, I think we're well poised to kind of come back around. But the fact that all-time highs within two years of all of that is pretty remarkable. And the fact that it didn't die, I think, is great and a real testament to the fact that it does seem hard to kill at this point, which is great. I think the existential risk for the asset class, that's one of the risks that's been kind of taken off the table this time around. So yeah, I would agree with that.

8:35The existential risk is off the table, which theoretically should put like, definitely not a ceiling on returns, but should perhaps damper some of the asymmetric upside. Like if that risk is off the table, then that risk premium does not exist anymore. And I want to push back respectfully a little bit. In the previous cycle, Bitcoin had an 83 % drawdown. in the most recent one. And I'm talking about the peak from 2017 to the bottom in 2019. In the most recent drawdown, it was 76%. So the drawdown terms were, it was barely a little bit less harsh. Although there was a big difference between 86 and 73 or whatever numbers I just said, 83 and 76.

9:15But the difference is the levels. The levels were different. So whereas in the previous cycle, this bottomed out at like 2000, recently, the bottom was way, way, way, way higher. like 15 ,000. So just sort of, I just remember at the time, Ben and I were talking like, why is this thing still catching some sort of bid? Like, why is there some sort of floor underneath this? That's not a question. It's just sort of a comment. I'm curious how you think about the overall ecosystem of crypto, because it's not just Bitcoin and Ethereum anymore. And then you have these other projects where people are trying to build some use cases and DeFi, maybe like try to build the, you know, the rails of the financial system kind of thing.

9:55And then you have the meme coins over here. So how do you reconcile that? Is it just because, hey, this is the internet and it's technology and this is the kind of stuff that happens on the internet? Because you see some of the extraordinary moves in some of these things that are more or less a joke. So how do you reconcile that with the actual building over here of a new technology and then this other stuff that's just kind of fun and entertaining for people, but it also makes some people money. Yeah, for sure. I mean, one of the beauties of crypto and digital assets is its open permissionless nature, right?

10:31So you can, anybody can go interact with these protocols and create new tokens and that lends itself to things like meme coins and, you know, gambling is a use case in the world. And it's one that, people, especially when they're lacking for other things to do, will take to it on chain. And meme coins is just an easy, I think, fun way that people have engaged in protocols and tokens. And it's quick, right? The feedback loop is short. People do like to kind of take those risks. And arguably, the risk return on some of those bets might be better than what they'd be doing with lottery tickets or whatnot, which is a pretty sizable TAM in the real world.

11:17But I think on the actual innovation side, the teams and projects that are building things that are really going to shape the internet, shape the financial system, that stuff obviously takes a lot more time. But it's kind of an amazing thing that these can coexist in the same kind of crypto world. And you can kind of have, you know, Chris Dixon talks about the global computer and the global casino. And obviously, you know, I think the investors that are really digging in and playing the long game here, we're really focused in what the global computer can do. But the global casino use case is there and it's attracting people and dollars.

11:57But it also it provides a good kind of resiliency check on these networks. It drives a lot of traffic. It identifies certain shortcomings with congestion or whatnot. And so there is some value into even that type of use case creating a lot of volume to stress test these networks. I've heard people say that, like, listen, speculation and gambling in a way is a way to get people's foot in the door. And then you build on top of that because, as you said, it provides the liquidity that you need for a system like this to function. Yeah, exactly. I mean, here in my little neighborhood, people have jumped online and engaged it.

12:35And that was their first interaction with, say, Solana and the Jupyter protocol. But once you go on there and you realize, wow, there's no kind of company or person, I can just go on there and I can buy a token and flip it on the weekend when markets generally aren't open. It does open their eyes to, okay, what would be possible doing other things? And it's that first experience. And then it's hard to unsee, right? I guess a little more pushback. And I do agree, or I believe that there will be future benefits to crypto in terms of use cases beyond speculating and investing. The however is venture capitalists poured many, many, many billions of dollars into this ecosystem.

13:23and you know better than I, I don't think I have enough information to say that there's nothing to show for it. But as what these people would call the normie, I haven't seen it. And most people haven't seen it. So do you think that there's going to require another wave of venture capital investments? Or do you think that the last wave is going to be sufficient for building something that, Whether it's a consumer killer app or something more behind the scenes and it's like the financial rails that we don't even know that we're interacting with, where do you stand on what I just said? Yeah. And I think what you're really getting at is the large VC dollar, specifically into crypto infrastructure.

14:07And I think there still needs to be some build-out and improvements there. I mean, we can't tokenize all the world's assets yet and put them on chain. The existing blockchains and existing infrastructure can't handle that volume yet. And so I think there is still more work to be done there. But obviously, people are interested for the kind of end user facing the killer apps, right? I mean, with AI, you have ChatGPT. It's very obvious, right? That kind of zero to one moment. And so I think people are looking for that in crypto. crypto. But you're starting to see some of that. I mean, we're a good example.

14:48We're able to run a fund on-chain, not at 10 % cheaper, but a fraction of the cost. It really is a game changer for us. And that's just one fund. And obviously, we're a huge fund complex, and there's a lot more to do there. But it really is a step-function change for us to be able to run a fund on-chain. I think an area that I'm super excited in is known as D-PIN, which is Decentralized Physical Infrastructure Networks. And what's cool about that is you're using token incentives to actually bootstrap networks that touch the real world, that touch the physical world. And so there's protocols out there.

15:27Hype Mapper is a great example. They've mapped 17 % of the entire world's roads using token incentives to kind of bootstrap that network. something that wouldn't have been possible without using kind of crypto, blockchain, rails, and these token incentives. So I think you're starting to see those real world applications, but people, I totally am. People are looking for that, that Chad GPT moment, that aha, you know, where you can ramp a hundred million users over, you know, basically overnight, right? Do you think that the lower fees in the financial system is a, is as good as any use case? Michael and I had a conversation with a friend of ours who's in crypto in New York this week.

16:02And he said the big game changer that he's looking for is upsetting the MasterCard's, Visa's, American Express's of the world who are taking 2 % and 3 % from every merchant when you swipe your credit card. And he's saying eventually you'll do that for a penny or a fraction of a penny or something on chain. Does that seem realistic to you? Yeah, I think, yeah, I do. But I think those players that you mentioned, they're also looking to get involved too. But the theme here is that basis quote, your margins by opportunity, one of the benefits of crypto is that it reduces the cost of trust. It takes out intermediaries.

16:42So that margin that's captured by the kind of Web 2.0 platform economy can now be captured by the users that own the network in the protocol economy. So this kind of this shift from Web 2 to Web 3, you know, where platforms own everything to users own everything via this protocol. I think I think that's a game changer, because once you own your data, once you own your economics, once you have skin in the game, it does kind of change the landscape. But I think you're going to see, you know, Visa, MasterCard, you're going to see all these players play in that Web 3 space as well. And, you know, the hope is it'll just it'll force them to reduce fees, right?

17:20Or be able to reduce fees. And I think the value proposition is not just a cost reduction, but it's what new revenues can be added and what new functionality can be added. So in payments, you can bring the cost way down, but you can also do things that make them programmable or streaming or micropayments. So you could add new functionality. I think that's where we get most interested when it's not just a cost reduction exercise, but how do you expand the design space, expand what you can do because of the technology. All right, let's talk about the investment case and what's going on with the prices.

17:53So the story of 2024 with digital assets is obviously the ETF. There's nine new entrants and it's just been a wildly successful new ETF launch. So we're recording on April 19th. By the time this comes out, But I'm sure prices will look different for better or for worse. We'll see. But without GBT, so even without the incumbent, there's nearly$33 billion in ETFs. I'm curious, with the benefit of hindsight, is this something that you thought was going to happen just in terms of, I mean, that's a large number. So love to hear your thoughts on how this happened. Yeah, it is a large number. And I was one of the many people that were tasked with trying to estimate like, look, how big could this be in year one?

18:51What's the ramp going to look like? And you're kind of doing the best you can analysis, sensitizing around the different ways it could play out. And the way it's actually played out year to date has exceeded those expectations. I think from a net flow basis to be at 12.3 billion right now, it's quite remarkable. And what it does for the space, I think, is huge. I think, and it's still early innings, right? I mean, there's so many platforms that are still in the education phase that are waiting for a certain amount of months to elapse with respect to kind of track record before they get comfortable with it.

19:31And so even though the flows have been quite strong so far, I think we're still kind of early days in the adoption through this door that's been opened. I know it's really hard to tell with ETFs. It's a little easier to tell with mutual funds for flows. Do you have any sense of the breakdown of money coming from retail versus institutional in terms of advisors and such? Is it impossible to know? Because that's something Michael and I've been trying to figure out is like, is this all just being driven by advisors putting, you know, 2 % of their client portfolios into Bitcoin or is this more retail driven?

20:04Yeah. So, um, so I don't sit, you know, directly, uh, close to close that information, but in my conversations, um, you know, my sense is that it's coming from a diversified sort of channels and it's kind of coming from all over. But, you know, for one I see also is that a lot of the big players, they're still doing work. I mean, what we've really found with this asset classes, education is key. And the kind of onboarding ramp to get comfortable with the asset class and its impact in a portfolio, it does take time. There's a lot of handholding. It's a process. So I would say, you know, from the people who have actually allocated dollars, from what I can tell and what I've heard, it's coming from a diversified set of sources.

20:46And then equally so, there are the institutions, the people kind of doing work that are kind of in that process, but haven't yet allocate. Yeah, I think that's probably right that it's coming from advisors, it's coming from individual investors, it's coming from family offices and institutional investors and all that sort of stuff. From our lens, I've been talking with our advisors and we're not getting an overwhelming amount of questions. In fact, it's been pretty quiet from clients, which I think probably for the listeners would tend to say, it's probably more bullish all else equal than not.

21:19So in terms of the price action, just very recently, one of the unique aspects of Bitcoin is that it is truly a 24-7 global asset. And over this weekend, when Iran attacked Israel, the S &P 500 wasn't trading. The US market wasn't open. European markets weren't open. Japanese markets weren't open. crypto was open. And you saw digital assets take a nosedive. And so do you think that digital assets are still in this stage a proxy for risk appetite? Yeah, I think they are viewed as, digital assets in general, viewed as a risk asset, kind of gets lumped into the alternative bucket. Certainly when you look at the asset class, it also gets kind of referred to as liquid venture because it's early stage technology.

22:18yet it's in this kind of liquid form. So I think all that is fair. Yeah, it is interesting. Some of the most volatile times have happened on weekends. And what other assets are traded, and you can see it. I actually first heard about the attack by all the alerts happening on crypto, and I was like, something must have happened. And then, of course, I see five minutes ago, the strike happened. So I think that's pretty interesting that you can get that feedback loop through the markets on the weekend. And while it has pulled back, obviously, geopolitical tension's higher. I think in addition to that, you have this kind of view that, hey, rates are going to be higher for longer.

22:56This also is happening around tax season and some selling there. And also, we've just had such gains coming into this, right? So I think a little bit of pullback isn't abnormal. I think when you look at past bull runs, 10 % to 30%, You know, pullbacks are very common within a bull cycle. So but, you know, this time, obviously, with, you know, what's happening on the geopolitical stage, you know, certainly it is different. It also happens to coincide with the halving. But, you know, last halving, 2020, we were in the middle of a global pandemic. So there is some precedent for, you know, a lot of uncertainty globally happening during these events.

23:34So you mentioned all of the dynamics that might be affecting crypto right now. Yes, it's had a hell of a run. It got as high as 74 and as low as 60, so around a 19 % drawdown. But given that we face higher rates, interest rates should be competition for risk assets, certainly Bitcoin and crypto as a risk asset. Given the geopolitical tensions and given the run, you would expect maybe one a little bit lower. So right now, Bitcoin is at$65 ,000. Do you think that part of the strength is because the halving is coming? And maybe for listeners that aren't quite familiar with the halving, please describe for them what it is and what that might be doing to put a bid under prices.

24:22Yeah. So I'll start with that. And I can touch on what I think, how much impact it's having. So the halving, pretty important and recurring event in the Bitcoin ecosystem. And basically what's happening here is that roughly every four years, the reward for mining a new Bitcoin gets cut in half. So that's why we call it the halving. The first one was in 2012. The current one is happening later on today, you know, for those in the States or tomorrow, Saturday, the 20th, you know, in Asia, it'll be the fourth halving in Bitcoin's history. And this time around that per block mining rewards going from six and a quarter Bitcoin to three and an eighth.

25:08and this will continue happening every roughly four years until the full 21 million are out in circulation. But it's an asymptotic lie basically, right? So this isn't actually going to happen until 2140 where all the Bitcoin are out. And why does this happen? Well, it was kind of built into the code base from the onset and it's designed to ensure that Bitcoin remains this kind of scarce deflationary digital monetary asset, which is pretty unique, right? To have a trillion dollar plus asset that, you know, whose supply is not a function of demand, but it's actually programmed in. And so, you know, it only happens once every four years and it's happening, you know, today, tomorrow.

25:52So that does happen to coincide with a lot of other things that are going on, including, you know, on the demand side, you talked about, you know, the ETB complex. So So it is pretty interesting that you're getting the supply cut at the same time you've seen demand through a new source of flow is happening. Well, how do you view the efficiency of this market? Because if this market was relatively efficient, this stuff is on schedule. It's not like this is a surprise to anyone. And Michael and I were talking about this with the ETF. It's like the ETF was this huge groundbreaking event that people were talking about for months and months leading up to it.