Talk Your Book: The Next Catalyst for Crypto Assets

0:00Today's Animal Spirits Talk Your Book is brought to you by Fidelity Digital Assets. Go to FidelityDigitalAssets.com to learn more about their research pieces on all things crypto. And check out their crypto ETFs for Bitcoin, FBTC, and Ethereum, FETH. It's FidelityDigitalAssets.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:40Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:48Welcome to Animal Spirits with Michael and Ben. Michael, I feel like every time we've talked about crypto for the past few years, you try to come up with a good use case, like title insurance or registration for something. I feel like you're a good salesman for the blockchain. You're trying. What if the real thing is just, it ends up slowly integrating with the rails of the financial system and there is never any consumer use case and it was just meant to be for financialization and that's it. Is that enough for you? Well, it could be. I think long-term, long-term. Listen, if it's good enough that the banks integrated into what they're doing, I would assume that at some point there's going to be some sort of consumer application, but maybe we don't need it.

1:33When I say we, I don't know why I'm saying we. I'm not necessarily from the community, although I support the community. I am a Bitcoin ETH holder. Chris said about the four-year cycle, us holding for four years, we've held for more than four years. I bought my first Bitcoin in June of 2020, I believe. I mean, mine was probably 2017 or so. I did a very small amount. But the thing is, people would be more concerned about use cases if the price was lower. If the price is high, no one cares about use. Very true. Price being in the 60, whatever thousands now, people would be way more concerned and up in arms if prices were much lower.

2:10Well, we've said this in the past. What if for Bitcoin specifically, I think ETH, there's got to be something. There's got to be a there there. For Bitcoin, though, it just works, right? It is what it is. It's never been hacked. The blockchain has never been down to the best of my knowledge. It just works. It does what it does. So on this episode, we get into the history of it, the adoption, what are advisors using it for? How are they thinking about it? What sort of questions are they asking? ETFs. The ETF, of course. So on today's show, we're joined by Matt Horn. Matt is the head of Digital Asset Strategies at Fidelity Digital asset management.

2:44We're also joined by Chris Kuyper, Director of Research at Fidelity Digital Assets. Stick around. Hope you enjoy the show.

2:52Chris and Matt, welcome back. Thanks for coming on today. Thanks for having us, guys. Pleasure to be back. Yeah, thank you. Okay, I'm going to start the show today with a little story, something that I experienced over the weekend. I took my family to the post office because we needed to get them passports. We're going out of the the country in December. And we get there. We're all prepared. We've got our forms. We've got the pictures. And he says, how long do you want to like expedited shipping or processing? And I said, well, give me, what are the options? Six to eight weeks or my six to eight weeks for, okay.

3:32You know, six to eight weeks, that's fine. December's further than that. So no big deal. How would you like to pay? Money order or check? Money order. What is a money order? I have no idea. I didn't have a check. So I said, yeah, let's go with the money order. Okay. So he punches me up$237. I take out my credit card, go to tap. Oh, sorry. We only take debit cards. You only take debit cards for a money order? What even year is this? So I don't know. He printed the money card, the debit card, the this, the that. Okay. Okay. Obviously, there's inefficiencies here. This is the government. We understand how that works.

4:10Is blockchain not a solution for these sort of financial transactions? And if so, what are we talking here? What would fix the money order nonsense? Well, I mean, I don't think you need a blockchain to fix that instance. But I think there are a lot of unique use cases for blockchain technology, and they're becoming more apparent over time. In your instance there, Michael, obviously, just the ability to accept traditional payment rails in the modern era would have worked. But really with blockchain, we're quite a ways into this now, right? Bitcoin came around 2009, Ethereum 2014, 2015. And you've seen a lot of different use cases being built more recently on top of these protocols.

4:53And it does get pretty interesting as to what you can predict a future state to be using this technology. people generally say, you know, what is the killer app for crypto at this point? And I'd argue there's many, but, you know, I think the most common one you would hear is around stable coins, right? The ability to take a fiat currency, US dollar, put it on blockchain, digitize it, make it instantly transferable globally as a digital bear instrument, right? It's like handing a dollar to a person globally instantly, right? The issue there, of course, is, you know, the inability of a stable coin to generate a yield.

5:30So there's sort of an opportunity cost by keeping your money in stable coins in a higher rate environment. So now we're seeing the proliferation of things like tokenized money market funds that are trying to solve that use case. I saw Circle made, somebody tweeted, Circle made more money last year than Goldman Sachs or last quarter or something. I believe it was Tethered on Circle. Oh, Tethered, that's right. Because to your point, there's a 5 % available and they're not paying it out. But it is kind of funny that we're however many years in. The white paper was, I don't know, 2009 or something.

6:00And Bitcoin and Ether, which we're going to spend the majority of the conversation today talking about, have become legitimate asset classes. But Matt, as you mentioned, really the killer use case today are stable coins, which I don't know if it's ironic or what the right word is, but it's kind of funny. Well, I want to talk about stable coins a little bit because I made the corollary a few years ago that stable, it's kind of like a money market, but also a currency Hedrick, how would you explain it to people who are unaware of how they work? You're getting the benefit of a currency you want, like the US dollar, but you're getting it on the blockchain rail.

6:33So you can do all the stuff you can do on blockchain, but you're using a US dollar rather than something else that you might not want to be exposed to, like the volatility of Bitcoin or Ether or something like that. And so, of course, there's that aspect of it. You've opened up anyone with an internet connection, especially to your point, Ben, I was a little surprised at the rise of stablecoin, but that's probably my myopic view as a citizen of a developed world. But you get into this and you start to see how important these things are in developing worlds for people to have access to them. It's like an instant bank account access or a way to get dollars where they might be banned or very hard to get.

7:14And then, of course, you have all the technological benefits of it. It removes so many frictions. You can verify stuff much easier. To Michael's point, it's not going to take days and weeks for this stuff to clear. It's almost instantaneous. Do we know? So that makes a lot of sense. Listen, we're US citizens. We have the strongest currency in the world. We don't necessarily need stable coins. What we have works pretty fine. Yeah, it could be better, I suppose, but it works pretty fine. Do we know how much of the stable coins outstanding are held overseas? Because if you tell me that 92 % of stable coins are held by Americans, well, then what are we doing here?

7:52It's definitely the majority is offshore, without a doubt. Because again, to Chris's point, we're the most developed nation, we don't need it, right? But if you think about the emerging world, the emerging world was sort of able, because they weren't the leading edge of technology adoption for the last 50 years here, They were able to kind of skip some of the things we went through here in the US, the landline phone, right, the dial-up internet. It kind of went right to cellular. So technology is now global in the palm of one's hand. And this technology now makes the ability to transfer value instantaneously with finite settlements, settlement assurances, the inability to easily counterfeit this currency.

8:35so it is attractive in many ways because for better or worse, the dollar still is the global currency for most nations, right? That's sort of what you go to, you travel anywhere, Michael, right? With your fresh new passport, you're going to have anywhere you go, they will likely take the dollar, right? Even if you don't have the local currency. And a stable coin is just a manifestation of this, of a tech, you know, just a current technology version of the dollar, essentially, right? Now, why is it interesting, right? You know, in a world of low interest rates five, six years ago, stable coins proliferated.

9:07But as rates rose, there was an opportunity cost then, right? Because if you were a crypto native firm or stable coin user storing your value in a stable coin and having to sit there, you are missing out on anywhere from three to 5 % yield. And I think that's why we've seen such a move here to find yield generating instruments that one can now hold in a similar vein. And that's your point earlier, that's why these stablecoin issuers for years have been making a very fat margin because they've been able to not pay a yield on the stablecoin while investing the collateral, the dollars, right, in US treasuries at, you know, 3 % to 5%.

9:41Unless you live outside the United States and your currency is weakened significantly against the dollar, then who cares about the 5 % yield? Fair enough. Yeah, there obviously is the purchasing power parity type narrative there for sure. But, you know, ceteris, peribus, whatever, all is equal, right? You know, I think the the opportunity cost of yield is where I see a lot of institutional players, right, that are operating on chain trading firms, crypto native hedge funds, crypto native firms that just keep a lot of their reserves or balance sheet on chain. They saw a massive opportunity cost there.

10:11And there was demand for yield on chain. And hence the developments we're seeing with yield generating instruments. All right. So let's get back to Bitcoin and Ether. It's been an exciting year for the two asset classes. The Bitcoin ETF, did it launch in January? January 11th. Okay. And Ether was June? When was it? Late July, July 23rd, I think it was. Okay. And it's been a raging success. At least Bitcoin has. We'll get to Ether in a minute. Are you guys surprised at A, the amount of flows into the Bitcoin ETFs? And are you also surprised that it hasn't led to substantially higher prices? Bitcoin has been acting well, better in the past week or a couple of weeks.

10:52But overall, yes, there was a huge run-up, but there's been a lot of sideways action for the last couple of months. For sure. Yeah. So to answer your first question, the flows were definitely a pleasant surprise, I would say, generally. I think it was very hard to handicap this category coming out as to what the demand would be because you had existing assets tied up in legacy products that were converting into the ETP structure. You had, I think it was 10 or 11 issuers launching all on the same day. So there was, again, a lot going on. But all in all, I would say this was a smash hit home run success for a new ETF category being Bitcoin.

11:29Very strong adoption across all client segments. You know, I see a retail still leading the way for the most part. Advisors coming in strong over time here, right, as they make their assessments and do the due diligence. And last but not least, we're seeing, you know, early adopters via, you know, the institutional channel using these ETPs. On the Bitcoin side, the one, I'd say, interesting development that really caught me by surprise was just the traditional hedge fund usage of these products. You look at some of the top products in the category, including Fidelity's, FBTC products, and a decent amount of hedge fund ownership.

12:06And they're using the exposure in a variety of different ways. Because they're in the ETP structure, they play easier in the traditional financial system, meaning they're marginable. there's an arbitrage trade going on for some of these hedge funds where they're buying the spot Bitcoin, ETP, selling forward the CME futures and locking in an arbitrage trade there. So I would say the institutionalization of these ETPs was one of the more shocking things to me this early. How does it impact when we see options and some other activity on top of these ETFs? Does that make a difference at all? It could.

12:40And it's hard to say exactly how options on the Bitcoin ETPs will play out over time. I think it's great because it just gives participants another instrument to hedge or do various trades in the long run. They just got approved, right? The Bitcoin ETF options? There's a process here. They're not approved. It was one leg in the process, but we're optimistic for hopefully working with regulators and the exchanges for sometime next year. But again, it'll be another tool in the tool chest here for market participants to use to put on either positive or negative exposures toward the asset class. Ethereum, I'd say a little bit earlier on the adoption curve.

13:20And I'd say that's not expected. Now, as an ETF category, the Ethereum, by all means, again, a smash hit. You're seeing, I think, well over 2 billion in gross flows into the new products in the category. Obviously, there was one existing product that has outflow, So it's sort of a muted kind of net flow. But overall, for a new ETP category,$2 billion in a month and a half, whatever it's been, is a smash hit home run. Now, Ether, I've been in crypto personally since 2016, 2017, and professionally for five years now. And in my opinion, it always starts with Bitcoin. So it's no surprise Bitcoin has the majority of the focus of the ETP flow.

14:03And Ethereum is coming on now. Ethereum, we can get into this a bit more. It's a much different use case. There's a lot more going on. There's different narratives playing out around Ethereum. It's definitely a bit more dynamic, I'd say, as a protocol than Bitcoin. And it just takes time to understand. And I think, frankly, advisors and institutional participants have enough time, have enough on their hands to figure out, how do I deal with Bitcoin, never mind Ethereum, right? So it sort of is an adoption curve of not just digital assets, but even within the digital asset system. Bitcoin generally goes first, Ethereum comes second.

14:39So I'm not shocked to see this lagging. Michael and I have talked a lot about the narrative and right or wrong that drives flows and interest for a lot of people. And we always said Bitcoin, the selling points for Bitcoin ETF are pretty simple. It's digital gold ETF, basically, right? Whether you believe that or not, that was a good selling point. It's a lot harder to pin down the Ethereum. So, Chris, how do you explain the Ethereum use case or investment case or whatever it is if you wanted to make it simple for someone who doesn't understand how all this blockchain stuff actually works? Yeah, like you said, we view them very differently.

15:11Bitcoin's kind of its own asset class, either if you want to talk about it like a commodity or like a non-sovereign currency that people are adopting. And the investment thesis is very clear there. It's something that's non-sovereign, has a finite amount, and it's the most decentralized one out there, market, shared, leading, all of those things. And then Ethereum, people used to lump them together. And now I think they're beginning to see that they're very different. And to be fair, they started a lot more similar. They were both proof of work consensus mechanisms, and we can talk about that.

15:45But Ethereum has undergone all of these changes and all of these upgrades. And so it's a very different asset class. And so the way I would think about it is you have Ethereum, the network, just like you have Bitcoin, the network. And it's all the computers running the Ethereum code. They're following the rules. They're processing these transactions, these things called smart contracts, which are little snippets of code that have to be run to make these decentralized applications built on it work. And then you have Ether, which is the native token to the Ethereum network. So this term gets thrown around a lot.

16:18We say Ethereum's trading at$2 ,600. whatever. What we actually mean is the Ether token. And the important thing to note is it's a purely digital token. You can hold it, you can send it to others, just like Bitcoin. It's not controlled by government. It's got its own issuance rule set. But the key difference is you need that Ether token to pay for computation on this network. So all these applications built on the Ethereum network, they have to run on the network that takes computational resources. And so you have to pay your way with the native Ether token. So from an investment thesis perspective, if you're going to invest in Ether, the token, and especially if you're just going to hold it, what you're betting on or investing in is this network getting bigger, more stuff getting built on it, more users coming to it.

17:05And therefore, people need to buy the token and hold it to do all these transactions on it and to run these computations and these decentralized applications on it. And fundamentally, every blockchain is trade-offs, right? It's sort of like trade-off between security and throughput. And how you want to optimize on that is sort of up to the community that's supporting that blockchain. And back to Ben's point, the Bitcoin blockchain is pretty straightforward. It doesn't change very often. It's slow to move. It's sort of ossified at this level for its use case, and it's doing exactly what it's designed to do very well.

17:44Ethereum has had a lot of changes over time and is very different and aspirational in what it's trying to do. So right now, and Chris, I love your thoughts on this too. This sort of is a battle for how to best optimize the block space, right? There's a finite amount of block space on Ethereum. There's layer twos that try to optimize some of that real estate on the block space. And how do they as a community to come together and optimize that for the best outcome for Ethereum. And I think it does get complicated for the average person to approach and try to understand what's going on. I'm in this space and it's a lot to follow, frankly, right?

18:19So nevermind a financial advisor or someone who's trying to understand how will value accrue to Ether over time. And to Chris's point, fundamentally, as there's more demand to use the Ethereum blockchain for whatever purpose it is, right? There's many purposes and use cases you can use it for. As there's demand to use it and spend Ethereum, right? Then the value of Ether should go up over time. So that's sort of the general North Star is that this is a very useful blockchain. There's a lot of useful actions and activities being done on this chain. And people want to hold and use Ether in this ecosystem.

18:55And that's fundamentally the driving force here. Yeah, I'll throw two - Are stable coins - Sorry, Chris. I'll just throw two analogies and I'll get to your question there because one is you could think of Ethereum like an app store. It's just this platform and then people build apps on top of it. And so if you think people are going to build more apps and more people are going to come to this app store and use these apps, the tokenomics say, or that's the idea that the value of Ether should go up. So that's one way to think about it. It's this blank canvas. Anyone can build all this stuff, but you got to pay your way with this Ether token.

19:29What about stable coins? Are they primarily built on top of the Ethereum blockchain? Yes, Ethereum has a majority of the stable coin market. There are other competing networks that are taking some as well, you know, a stable coin. And one stable coin can operate on multiple blockchains as well. I'm not even going to dig deeper into that because that sounds like a worm. All right, go ahead. So what is ETH being used for? We just released a report, Max Waddington on my team, very sharp guy when it comes to Ethereum. It talks more about the investment use case and he goes through the stats on what is ETH used for.

20:03The number one, 34 % of all ETH activities is just ETH transfers. So just like the Bitcoin network, transferring Ether from one wallet to another. Stablecoins is at 12%. Decentralized finance applications are 13%. ERC-20 tokens. So these are different tokens. Non-native tokens are 14%. And then the rest of the bucket is 27 % of all other things. It seems to me that a lot of this tokenization stuff, and maybe this is just the point, it's just there's a lot of, it's all financialization. It's a lot of swapping. It's a lot of back and forth. I don't know if this is a criticism, but I think that a lot of people outside the crypto ecosystem would say, well, what the hell, what is it for?

20:46Like when is it going to ever do anything other than just be a financial instrument? Is there going to be a consumer application? Does it does there need to be a consumer application? Well, I think there's two ways to think about it. Number one is, yes, I agree with you. Most of the activity, the things I just ran through are financial nature. So ETH transfers, if you're transferring value, I would say that's financial. Decentralized finance, that's obviously financial. Stablecoins, that's financial too. So that other category, 27%, you've got things in there like gaming, collectibles, NFTs, social apps, that is there, but it's smaller.

21:21So you bring up a great question of, does Ethereum move beyond just financial applications, or is this going to be its continued use case? But I would say there are, and there will continue to be consumer applications on these things. You've already seen it. There's obviously a need for consumers to do financial things in a much more frictionless or efficient way. And especially if you're not in the US where you already have a lot of great apps and companies and things like that. One potential use case that I haven't seen proliferate yet, maybe I'm just making this up, so check me if I'm wrong.

22:01Michael's an ideas guy when it comes to crypto. Yeah, I'm just throwing some shit against the wall to see what sticks. Like live events. I've been to a million Nick games and guess how many, guess if you asked me to pull up a record of, was I at that game? Have I seen this player? I don't know. I have no idea. Like what about just NFTs for concerts, for sport, for sporting events, for reservations, things like that? I think it's funny you said that. I heard someone talking about this the other day, where they said the good old days of concerts where you had the concert stub, you'd say, I was at that concert, you know, whatever, Grateful Dead and whatever, right?

22:35I think that's interesting. Why not, right? I do think, absolutely, these blockchains are ledgers. They record data and keep it in a decentralized location for history, right? And so I absolutely think you could do something like that, where you had an NFT that shows you were at some event, right? I think that's interesting, right? You had the game six of the Knicks playoff game or whatever, right? I think that would be an interesting use case. So the current use cases for investors now, if they're in the ETF, I'm curious how you see people using, if they're using both ETFs? Because I'm not sure the latest breakdown, what is it?

23:07Maybe if you broke down Bitcoin and Ether market caps, it's 80-20. Is that right? Close or not really? The market cap of Bitcoin and ETH? Yeah, Bitcoin versus ETH. I'm saying it's just the two of them. It's like 70-30, roughly, give or take. Okay, 70-30. So I'm curious if you see anyone, if you see a lot of investors that hold both ETFs doing that, do you see a lot of people trying to get those similar? Or is Bitcoin still just a much bigger piece in most people's portfolios if they're using ETFs? Yeah, without a doubt, it is Bitcoin is the majority of that position, right? I would argue 90 % of the digital asset ETPs that are held out there, they're just holding mostly just Bitcoin.