E308: The Future of LP Liquidity

0:00David Weisburd:When a lot of people hear leveraging your stocks, they inherently think that it's highly risky. Why is that a good idea for everyday investors?

0:09Yuval Rooz:Well, I mean, leverage, generally speaking, is associated with bad or potentially risky. Again, I go back to the example. If you take a mortgage against your house, you are leveraging the place that you live in. You could lose that if you don't pay back the loan. And it's really a question of what kind of leverage you take. For what reason do you take it? Right. If you're just if you're just taking crazy leverage to get even more exposure to the market, well, just be aware back to our points about how to think about risk. Well, if that thing goes against you, you could lose all of your wealth very quickly.

0:45Yuval Rooz:And as long as you understand the outcomes and you're a professional about it, then, you know, hedge funds do go to higher leverage and, you know, face outcomes. The question is, if you wanted to use 50 % of your portfolio against a house and you could meet those payments, that could just be another asset class where you might get a better lending rate. because a house is not as efficient or not as liquid as the equity market that someone that actually might lend you for buying a house at a much better rate than what a bank would give you, for example, against the deed of your house, which might not be very easy to liquidate.

1:24Yuval Rooz:So to me, leverage is just driving utility out of your assets. There could be bad leverage and there's good leverage. I mean, if you can borrow cheaper than what a bank would lend you, I would say, depending again for what you're using that loan for, that actually is a good outcome for the consumer because we're not getting away.

1:44David Weisburd:How does Canton enable that and what markets are you plugging into and going in between?

1:51Yuval Rooz:At the end of the day, what financial services are, are a bunch of ledgers that just agree on book entries or who owes who what money, or if I took a loan against something that the asset that I loaned against is encumbered or cannot be used for something else. So that coordination of all of these ledgers is really where the inefficiency today exists. That's where all the operational costs, legal costs, all those legal documents that we sign. So really what blockchain technology in general and Canton inherently does the same is really how do we streamline the management of these books and records across all these different financial players.

2:33Yuval Rooz:So what we're doing is we're focusing on capital markets to begin with. So we just announced with DTCC the first U.S. treasury that would be able to be available on Canton. So you'll be able to move U.S. treasuries in real time 24-7. We work on private markets, so private equity, private credit. But we do stuff in insurance, commodities, mortgages, and pretty much every financial instrument that you can imagine.

3:05David Weisburd:One of the biggest headwinds in LP world is DPI right now. It's the hottest topic. Every endowment, pension fund, foundation, family office is saying, I need to get capital return from private equity. Does Canton solve this problem over the long term? And if so, in what way? One of the hardest things of investing is seeing what's shifting before everyone else does. For decades, only the largest hedge funds could afford extensive channel research programs to spot inflection points before earnings and to stay ahead of consensus. Meanwhile, smaller funds have been forced to cobble together ad hoc channel intelligence or rely on stale reports from sell-side shops.

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4:47Yuval Rooz:Yes and no, right? So, and I'm not going to be the person who says that everything with tokenization gets solved just because you tokenize something or you put it on a blockchain. One of the challenges in doing, for example, like you mentioned DPI's is what does it mean to administrate doing that? Right. So one element of that is when I think about these greenfield funds is can I actually manage my, right, my distributions, my cash withdrawal versus deposits? And I would say that that has nothing to do with blockchain, right? That's just, do I have a strategy where the manner in which I deploy capital to which I can project cash withdrawals, right?

5:30Yuval Rooz:So I can actually on a quarterly basis feed these withdrawals. Do I have a business model that actually supports it? Assuming that I had zero friction in the underlying infrastructure. And that is unrelated to blockchain. I think that there's a very big component of the infrastructure not being as efficient as possible to actually help administrate these things very efficiently. Because if it takes me a very long time to onboard new customers and do capital calls, well, then my capital distributions also will have this inherent latency in it. So I think that when it comes to the efficiency of these funds, there's a lot and we're doing quite a lot of work there.

6:14Yuval Rooz:I think the other thing, and we talk about this utility, is today the only way for LPs, for the most part, to get money out is by selling their holding. And that's just one way of doing it. I think that, again, if we increase the utility of these assets and you gave LPs tools to borrow more efficiently against some of their holdings, that also can alleviate some of the requirements of I have to get the money out. I have to sell my position versus I can just borrow against my position. And again, this, this idea of creating more utility and leverage of these assets is definitely something that we can be helpful with.

6:54David Weisburd:And on a basic level, you invested in, let's say Citadel as an LP, you have a $10 million position, the blockchain ascertains the value of that position, the custody of that position that you actually own that position. And because of that, you could buy, sell, or borrow against it.

7:10Yuval Rooz:There is a lot of people that would be willing to lend you. against your$10 million position. So if you have a$10 million position, and for whatever reason, you just needed$5 million right now, you would rather, given like you said, it's very hard to get into Citadel, can you actually borrow against that$10 million? And can you do that in a way that is so cheap and effective? Because a lot of times, a lot of people will say, yes, you've all, but you could do those things. So that people put these positions into SPVs and then they do all of these things. When you actually end up looking at the cost, the operational cost that it takes to set these things up and to actually administrate them, these loans or these things become so expensive that when you compare them to anything else that is available to you to borrow against, it becomes very unattractive.

7:54Yuval Rooz:And that's why I'm saying like what we're trying to do is we're trying to reduce the OPEX and the friction associated with these products to be just as efficient as buying and trading equities. And it doesn't necessarily mean that you'll just be able to buy and trade it 24-7. But if you were to do that, it would be just as efficient as taking a loan against any other asset class.

8:14David Weisburd:How do you standardize anything from Citadel to a private equity fund to a helicopter leasing fund? How do you standardize all of finance into one blockchain?

8:23Yuval Rooz:The question actually implies, in my opinion, the hardest challenge in this industry. But I will put a small correction. The blockchain itself is just a very advanced database technology. So it is just a technology. I think your question, though, does point out to a bigger challenge that the industry have with or without blockchain, which is in order to have these efficiencies and kind of stream through processing, alignment around data models and how do you process these things is a big component of it. The reason why equities or treasuries are the biggest markets and are as efficient is because they are standardized products, right?

9:05Yuval Rooz:There is no special treasuries, right? It's just one type of treasury. You have different durations, you have different coupons, but those are just plugins, right? The treasury is a treasury is a treasury. And I think that that's a very good point. And one of the challenges of private markets, very specifically, is there a non-standardized kind of model? So one of the things that we're doing there is we're trying to come up with as many templates as possible where you could have the uniqueness, whether you want, of a fund or a helicopter. But at their core, they do kind of distill down to kind of similar templates at the bottom layer.

9:46Yuval Rooz:But again, that's easier said than done. I think it's the biggest challenge of the industry. It's not necessarily because it's on blockchain, but how do you standardize these contractual agreements in order to have this kind of scaling?

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11:24Yuval Rooz:We rely on some of the clients starting to publish their activity numbers. So for example, Broadridge built an application on Canton, which is to more efficiently manage the US treasury repo market. So they do bilateral repo, intradealer repo, intraday repo. And today they're getting close to 10 % of the daily volume of that market. So I don't get to see which client of theirs have been onboarded, who trades what, but they do publish daily volumes of what they are doing on the platform. So we have a company called Zinnia. They're in the life insurance and annuity. We know that they're issuing life insurance products.

12:07Yuval Rooz:I don't know what is the quantum, but we are hopefully soon going to start being able to see how many policies have been issued over time. And that just goes, so what we are doing is we are working with all of our clients to try to have more real-time reporting of the activity that they're doing on the network. But again, it's their proprietary information, and that's the best that we can do. Our belief is that to date, we have seen the digitization or tokenization of a few trillion dollars of U.S. treasuries. And activity on a daily basis is in the hundreds of billions of dollars across the network.

12:45Yuval Rooz:But we're trying to bring more transparency into kind of like the daily numbers from those players.

12:53David Weisburd:What's one key thing that you've changed your opinion on in the last 12 months?

12:58Yuval Rooz:It's not in the last 12 months, but it's something that I've learned is, you know, as an engineer, you always assume that things will just steer towards the right solution from a capital cost, capital structure, efficiency. That is just not the case. I'll give you an example. syndicated loans take over three weeks to settle on average. I don't think that that's the case. I don't think that it needs to take this long. And the question is, well, why hasn't it improved over time? And when you end up looking at kind of like who wins from the float, sitting over a settlement time that is over three weeks, you kind of understand, okay, well, there's reasons why things aren't becoming efficient.

13:39Yuval Rooz:So a lot of times, you know, people, when they use technology, and this was maybe my biggest lesson learned as a CEO of a tech company, you really need to understand who are the winners of the current system. What are the reasons for not innovating? What is the reason for not bringing the efficiency to date? Because a lot of times people will think, oh, it's because the technology didn't exist. That's why the efficiency haven't come to place. And I would say that probably more than 80 % of the time, it's because there are certain key players in the value chain that have no interest in efficiency being introduced.

14:18Yuval Rooz:Efficiency is, you know, I always say friction. You can think of friction as cost. And cost means revenue to someone. Right? And sometimes that revenue is even with a nice margin. It's not just like, it's not just people cost.

14:32David Weisburd:someone's inefficiency is somebody else's profit center.

14:35Yuval Rooz:I think that's the biggest lesson learned for me is a lot of times you're seeing an inefficiency and you're seeing dollar signs. Oh my God, if I can just solve this inefficiency with my technology, life would be better. And you're like, because the inefficiency is so blatant and so big, you're like, okay, there's so much money can be done. And then you chase something like that for years and you just realize the players that are going to be disrupted from said inefficiency are just too in control over that market that it's not necessarily the best place to spend your resources or goodwill.

15:07David Weisburd:Over the last 18 years, if you could go back when you first started at Citadel, what is one piece of timeless advice that you'd give a younger Yuval that would have either accelerated your career or helped you avoid cost and mistakes?

15:20Yuval Rooz:It's a very simple idea. You look at these portfolio kind of allocation. How do you know if you're younger, more equities, less fixed income as you get older, more fixed income. I actually think that that's a very good advice. Also, from a career perspective, I wish I took more risk early in my career. And this is the advice I give for people that are fresh out of college is they keep on worrying about, you know, how their career will look like in 20 years. And I keep on saying you don't need to worry about that. You need to worry about it.

15:50David Weisburd:Don't you think there's a survivorship bias there? You obviously ended up being extremely successful, but not all simulations would have led to that outcome. 100%.

15:59Yuval Rooz:But I still look back at some opportunities that I had that I did take a conservative approach. You could look at a lot of people in crypto. I have a funny story of someone who told me, I won't say the names, but told me that the SEC were going after them in the previous administration. And the CEO said, yeah, we're just not going to respond to this. We're just going to stay away from the U.S. And when the new administration came in, said former boss and the person I know an email say, I told you, you know, it's like, and I'm not saying that that's necessarily the right thing to do, but my point is even through digital asset, I think that there were better, more opportunities where I should have taken more risk in the early days of the company that set the trajectory better long term.

16:50Yuval Rooz:I think that a lot of people are very focused of how their boss would view them in the early days of their career. And I just think that the trajectory of mistakes you do early on have, you know, I'm not saying again, I'm not saying that I, you know, you know perfectly what will happen, but I think that creating the right starting point requires taking risk, where if you play very conservative, it's not saying that you can't be successful, but I do think that you really cap your upside early on. And again, I think that the downside is very limited early in your career.

17:26David Weisburd:Most people are too conservative. So telling people to take risks brings them back closer to efficient frontier than if they were super risk taking, then you would actually probably get the opposite.

17:34Yuval Rooz:Correct. But I do see a lot of young students today being extremely concerned about how their career would look like 20 years from now. And I'm saying like, you really have not that much control of what will happen in 20 years. Make sure that you are doing things that you think could make a difference. And I think that that means taking risks.

17:56David Weisburd:What did they say? A students work for B students by companies founded by C students? Exactly. Exactly. Well, Yvald, thanks so much for jumping on the podcast. Looking forward to continuing this live.