How Do You Trade a Sideways Market?

0:00Your favorite neighborhood spot grows with Square. Indeed, my favorite neighborhood spot has quickly become Todd Snyder in Williamsburg. Todd Snyder is one of my favorite menswear shops and has supplied me with all the clothes I have needed this quite hot summer. Every business has different goals, but Square is the business platform that supports them all. From opening a new location, selling something new, or just expanding their reach. Indeed, I've seen it with Todd Snyder. In Square, also, you can get real-time insights, so don't wait for end-of-day reports. Go to square.com forward slash go forward slash real vision to learn more about how your business can grow with Square.

0:43That's S-Q-U-A-R-E dot com slash G-O slash R-E-A-L-V-I-S-I-O-N. Our story begins in 2014, after the largest financial crisis the world had ever experienced since the crash of 1929. Since then, we've made it our mission to democratize the very best financial intelligence. We broke the story of Bitcoin in 2014 before the general public even knew what it was. We've made award-winning documentaries and series about some of the most important economic and geopolitical events of our time that have amassed millions of views across platforms. And we've spoken with investing legends about trends years before they played out.

1:30Here at Real Vision, we don't follow the news, we make the news. This week on social media, we'll be showcasing some of the most important pieces in our history, unlocking some of them for you to watch for free, and sharing important takeaways from them that will be useful for you in today's markets. So be sure to tune in. We also have a very special offer just for you guys. To learn more, simply click on the link in the description or scan the QR code.

2:10What's up, guys? It's Ash Bennington. Welcome to Real Vision Crypto Daily Briefing. Before I bring in our guest, I want to talk about an exciting initiative here at Real Vision, the mint for season two of the real vision collective is happening right now the aim of the rv collective is to bring all your favorite nft communities together while giving you the knowledge you need to navigate web three season two is the next step in this journey to create this collective we've pulled artwork from nine of the most significant cco projects out there and transform them into three unique mashups if you want to help us keep building the super community of nfts head over to realvision.com forward slash collective.

2:51That's realvision.com forward slash collective to learn more and mint your own season two NFTs. With that said, let's bring in today's guest. Joining me today is Michael Safai, co-founder of Dexterity Capital. Michael, welcome to the show. Hey, thanks so much. Great to be here. Michael, it's a pleasure to have you. You and I were geeking out a little bit about traditional finance capital markets before the show started. You have a really interesting background. Tell us a little bit about your background and how you got into the crypto space. Oh, gosh. I'm from the West Coast. I'm from San Francisco.

3:28Years ago, I used to be a lawyer. But before that, I studied physical sciences at university. I had a legal mind to it, but I could also do some math, which is unusual for that profession, as it were. Extremely unusual, as many of my lawyer friends tell me. They always get the billables right, though, which is weird. But beyond that, not much math. But great for doing math in six-minute increments. Yeah, exactly. They always know exactly what a tenth of an hour is. But yeah, since then, I've done a number of things. I practiced law for a while. Then being in San Francisco, I ended up working at startups and really learned how to build a business, how to build technology and teams in a really effective but lightweight way.

4:14And, you know, when I left the last company I was at, you know, I had some time off. We did well. It was chilling. And one of my former colleagues said, hey, let's do something. And this was late 2017. And I said, great, pitch me five ideas. And the stupidest one was in crypto. So I said, let's do that one. Because, you know, if that wins, that will win big. And if it's stupid, well, I do lots of stupid things. So that's fine. And, you know, it turned out to work really well. So that's kind of how we got here. So tell us, what was that so-called stupid idea? Oh, God, the original idea was doing a decentralized version of Moody's or S &P's to rate ICOs.

4:52Because, you know, you really didn't think there was enough fundamentals in there and good analysis. It was all frothy. And so we thought we could create a fair game where you couldn't kind of game the system in terms of what your rating was in ICO. And it was a crazy idea and it was never going to work. But lots of things that never were going to work were very successful back then. And as we did the research, we started looking at numbers on these decentralized exchanges. Like back then, there was EtherDelta or Bancor or Kyber, some of which are still around. And we looked at the markets. We're like, wow, these are broken.

5:23The order books are crossing. There's no automatic matching. There's fat fingers every 10 seconds. There's kind of free money here. And so we started building these contracts that could do atomic swaps on these exchanges. in a very fast and very intelligent way. And that was a fun game for us. And that worked really well. So that's where we started. But come about 2018, when the ICO boom was cooling down, we thought, you know, need a more sophisticated way of trading. So we hired guys from places like Jump and Tower and built a more traditional HFT-style shop. And that's what Dexterity primarily is today.

5:59Like any good Silicon Valley idea, it morphed and moved to where the market was and where the product market fit was. Talk a little bit about what you're doing at Dexterity right now. So our bread and butter is proprietary trading. We do low latency, high frequency trading of cryptocurrency assets. And our trades are market neutral. So we're indifferent to price. We're not riding waves up and down. We're looking for volatility. We're looking for volume. And that's what we're really good at. And so over the past maybe two or three years, we've traded a little over$2 trillion in crypto assets. Yeah, these are huge numbers.

6:32So folks who have backgrounds in traditional capital markets, HFT, understand this model very well. But for folks who are coming to us native from the crypto space who maybe have backgrounds in engineering or something related in the technology space who don't understand the HFT model, talk a little bit about this and how it works. Sure. I think crypto, unlike TradFi, is a bit unique in that there's tons of venues trading the same assets. Like every exchange has Bitcoin. And there's lots of different pairs. You might get Bitcoin margined in Tether or USDC or formerly BUSD or other things like that.

7:07Or in Ether. You might even have a Quanto situation where you're using some other cryptocurrency to margin your trades. What that means is that while you'd like to think all the prices are the same across all venues, across all products at the same time, they just aren't. And there's lots of nuances built into that. So what we look for is kind of price dislocations and inefficiencies that don't make sense, that are wrong, and then go sew those prices up. And we do have to do it very fast because these price differentials are very small. So you can't just do 10 trades a day and make your P &L. You have to do 100 ,000 trades a day.

7:40And just to do that, you have to build some software that's very fast and very smart and plugs into all the exchanges in the optimal way so that you can capture those little price differences in your 100 ,000 trades to make a good P &L for the day. So that's the short of it. Yeah. And to talk to folks on the opposite side of the spectrum, folks who've come to us from the traditional finance capital markets space, there's something, of course, that you're familiar with called REG NMS, NBBO, National Best Bid Best Offer. Nothing like that exists in the crypto space. So you do get these dislocations.

8:10Let's talk a little bit about that framework, Michael. The dislocations, as you put it, the price deltas have narrowed pretty considerably over the last decade or so in crypto, but are still very high by traditional capital market standards. Talk a little bit about how great those price differentials are and also about the role that derivatives play versus the underlying in this game that you guys are playing. Yeah, I mean, the market's pretty sophisticated now. So the price differentials are quite tight, as you said. If we're talking about back in 2018, you could see really some irrational price differentials, especially along the kind of long tail coins.

8:46So it's small and it gets smaller every year, I think. But that's kind of been our sweet spot. in terms of figuring out how to work that. And the other unique thing about crypto, as you said, we've got weird derivatives products. We have a perpetual swap, which doesn't exist anywhere else, which is a future or a swap that just does not settle. Instead, every eight hours, somebody gets charged or paid a funding rate for being on one side of the swap price versus the perpetual swap's price. This is a hard thing to model because you have to guess how much you're going to get paid in eight hours, depending on where you are now.

9:20And as that funding rate fluctuates over the eight hours, You have to adjust your positions on both sides because, like us, we're fully hedged. We're market neutral. So this unique product has created a lot of interesting opportunities for people who like to nerd out on the maths behind all this stuff. Yeah, so how do you guys go about that in terms of the team construction, in terms of the trading strategies, just in terms of the operational aspect of it? Because, as you point out, it's a product that just does not exist in traditional capital markets. Yeah, and happily, we tackled this back in 2018.

9:54And so we spent a lot of time and collected a lot of data trying to figure out how to model this perpetual swap. And we got quite good at it. And the backgrounds of people are what you'd expect. They're people from big TradFi trading shops who had done lots of different things. Some people did FX. Some did oil and gas. Some did commodities. But they have that kind of instinct for game theory. That's what they love. They love figuring out how the game works and cutting through it. So Cryptos is just a giant game theory experiment with a bunch of kind of retail DJs thrown in. So it makes for a really exciting game to analyze because it's not always rational.

10:34But yeah, I think that's it. You need to find people who love solving really hard problems, who can't help but solve hard problems if you put one in front of them. If you ever heard the term nerd sniping, it's kind of, you know, if you want to distract somebody, give them a question that's just hypothetical and useless, but really interesting mathematically. And they'll totally forget what they're doing to solve it. Those are the kind of people who win at this game. So what's the landscape look like? Who are your competitors? Who are the counterparties? How does that work? Yeah, so in terms of competitors, there's two major categories.

11:02There's the TradFi guys who have come in primarily around 2019, 2020, and many of them have now departed. And then you've got the crypto natives who are like us, who have built just for crypto, because it's kind of easier to get into crypto than TradFi. Building HFT and TradFi is a$10 million outlay just to get started. In crypto, it's nothing. It's pretty much free because you don't need a lot of hardware. But back to your question, in terms of the competitors, I mean, in TradFi, we saw the influx of guys like Jump and Tower and Jane Street, Hudson River. These guys came in hard in the past few years.

11:38um and did really well i think um it was kind of interesting so it was additive for us they didn't eat our lunch they made it so there was more lunch for everybody to eat um so it was a really good time having them in there um but as you've seen a lot of pullback over the past few months and that's been kind of a bummer all around yeah how many of them have jumped out you know i think in size almost all of them there might be one or two that are still lingering But I think one shop I spoke to put it really well where they said, look, crypto is single digits of our revenue in terms of percentages, a single digit percentage, but it's 95 % of my PR problem.

12:17And if you're a prop shop, you don't want a big PR department. You want to lay low and hang out and make money and have nobody know how. So these guys, they could have kept doing it indefinitely. There was no reason for them to stop other than the bad PR was just did not outweigh kind of what was going on and how much revenue they were making from this business. Hey, everyone, we're going to take a quick pause and hear a word from our partners. We'll be right back.

12:44Yeah, that makes perfect sense. I guess second best is to have nobody know how you make money. First best is to have nobody know you exist if you're a prop shop. Yeah. Yeah, exactly right. I mean, we deal in secrets. There's maybe on the order of thousands of people who know well and understand what shops like ours do. It's a small club. And it's a bunch of weird people, too. So we don't like the limelight necessarily. Yeah. So let's talk about the broader crypto landscape right now in terms of price action, in terms of what you guys are seeing. What's the overall 50 ,000-foot overview of how you would describe this market right now?

13:23Volumes have cratered. um this is like um this is like it's like christmas when nobody's trading because everyone's on holiday or something all the time it's christmas every day in a bad way um so christmas every day in a bad way i love that yeah yeah you got to find a way to you know be negative about christmas i suppose um so anyways it's it's very very quiet um retail they pulled out because they They got burned very badly last year. Big shops, they kind of, tradify big shops, that is, they've kind of pulled out because of all the regulatory stuff and all the bad press. And then you've got very high interest rates, which make it just less attractive to be in a high-risk environment.

14:05So it's just very quiet. It's the best way to describe it. Yeah. And what about the regulatory headwinds? How does that affect what you do? You know, as a prop shop, we're kind of, we don't have a super heavy duty regulatory work. We're not trading other people's money. We're not hurting anybody. We're a fairly kind of easier business to run in that way. And that's part of the reason we aren't a hedge fund. But we are keeping in mind, keeping eyes on what's happening because it affects our counterparts and it affects the venues we're trading on and what kind of assets we can trade. And it's interesting.

14:43We've seen, you know, I'm an ex-lawyer, as I said, so I have a little bit of background in this. We've been watching the SEC fight in the courts, and it's just, it's not going the way they planned, I think. So I'm really uncertain how Congress is going to approach this over the next year. That Ripple ruling maybe a month or two ago that effectively said Ripple wasn't a security or didn't pass the Howey test when it was sold to retail on exchanges because it was a blind order book. That was not something I've ever seen before or thought was plausible. and it's kind of turned the whole situation on its head.

15:15Yeah. I think that ruling was especially confounding to us non-lawyers because it seemed to suggest that institutional sales were problematic whereas retail sales were not, which tends to be the exact sort of mirror image opposite of what you expect in terms of investor protections. But I guess Judge Annalisa Torres' decision essentially was about the manner of sale rather than the underlying properties of the asset itself being a security or not being a security, which I think was kind of a curveball. As you said, no one expected it. Yeah, I think if that ruling stands, it leads to absurd outcomes where you can issue tokens willy-nilly so long as you don't sell them to institutions and you only sell them kind of blindly on exchanges and via airdrops, which are free, so they're not sales and therefore don't meet the first problem of a highway test.

16:04Well, you can make any token and say it's not a security. So I think the SEC has to fight this and they have to get it overturned. otherwise the world is topsy-terropy. Hey, let me ask you this as a former lawyer. I don't know how closely you're following the story, but one of the things that was very confusing to me in terms of just trying to understand the big picture was the actual appellate process for this phrase interlocutory appeal, the idea that you had essentially a limited window to file a special type of appeal or the other aspects of the case that are still pending, which are the suits against Mr.

16:38Garlinghouse and Mr. Larson would essentially delay the final disposition of the case. I don't know if I've done that any justice, but how do you think about that? How do you understand what's happening there? Yeah, and forgive me, it's been a long time since I've litigated, but I think you're fundamentally right here. Do you let the rest of the case that is unaffected by this particular section of the ruling go on while the appellate process occurs independently, or do you pause everything? Yeah, and by the way, and the reason for people who are wondering why I'm asking this question, The reason why this is important is because if you have to wait until the final disposition of all the other aspects of the case, what it means is you almost have a kind of de facto presence, precedent set in the Southern District of New York for this sort of general framework of interpreting how things could not be a security.

17:20I know it gets confusing, but that's sort of how I think about it, at least. Yeah, I think that's right. But I do think, I'm forgetting the name of it, there was another case recently where, and it was in the Southern District of New York, where a different judge specifically cited her opinion on that matter and disputed it. So I think actually it's quite hard now to say there's any precedence, even in the meantime, while this appellate process unwinds. But yeah, I'm not sure what the strategy is there. I think it's a function of how urgent you think this is and how crucial it is to your case.

17:49If there's not much case left for you, then why bother going on with the rest of that case? I think they got something good here with that summary judgment on the institutional bit. But they really need to sew up that retail bit to get what they want as the SEC. You know, it just sort of makes you realize as we talk about this, talk about the framework for trading, we talk about the legal, regulatory, and compliance framework, just how early it is in this space. You know, you and I were talking, I was telling you this story right before I logged on to do the show. I saw two headlines about the Coinbase tender offer, one of which said that bonds were being bought at a discount.

18:22The other one said they were being bought at a premium. It's just like folks in this space, not criticizing journalists particularly, but it makes sense if you're someone who comes to us with a background in programming and engineering and you read these articles, you read the press release in this case from Coinbase, it's really hard and confusing to understand what's going on. By the way, the bonds are trading at 65. It's definitely at a discount with an early tender premium. But the point of the matter is it's challenging to build up almost this intellectual infrastructure in the space. People who understand, for example, the very complex technical issues, the very complex legal, regulatory, and compliance issues, and the very complex, frankly, financial issues that we've learned in what people outside the space call TradFi, what we would call capital market space, versus the cryptocurrency.

19:07I mean, it's just an incredibly complex space. And it causes, to a certain extent, I guess you could say, the kind of price dislocations that you guys trade on. yeah i think i think there's a certain cachet to crypto where it's so bloody complex that you just have to be really deep in the weeds to get a handle on it but so many of the big exchanges have a job of bringing in casual investors and retail traders who didn't really know what they were doing um and that made for kind of a toxic mix in a lot of ways not that that doesn't happen in traditional markets too it certainly does but it was kind of next level and the thing i always point to in DeFi, which I would love to be successful, but I'm a little pessimistic about is we're still using MetaMask, which really hasn't changed a whole lot in the five or six years I've been using it.

19:51And it still is just so difficult to get through if you're a neophyte at this kind of stuff. Yeah. So it is kind of the purview of a bunch of small group of nerds, kind of what it is stuff. Hey, everyone, we're gonna take another quick break and hear a word from our partners. We'll be right back to the Real Vision crypto daily briefing.

20:12Yeah, I always say that my mother does not have a MetaMask account. And it speaks to this point. Thank God for that. Yes, Mom, don't get one. There goes your inheritance. But it is kind of funny, though, this idea of UI and UX in the space. The reality is there's just a significant barrier to entry for a lot of people because the user experience, the user interface is just very complex. And I guess the interesting side about it is it does create this kind of cool, interesting place where DGENs like to play. And it's fun and it's interesting. We've got a lot of smart people who are doing things.

20:46But it is also interesting to think about what happens when those UI UX issues get solved. And we are able to cross the chasm into a broader, wider represented space in terms of people from the general public getting involved. Because the underlying technology and the potential, the promise for this technology is just really cool. And it's very obvious when you start to sort of wind yourself into it, the importance and the opportunities that come with the kind of true decentralization that this space can represent at its best. Yeah, it's absolutely amazing technology. I think there's a few ways it goes.

21:23I mean, blockchain technology already is amazing. It replaces buildings. It replaces banks. It takes 10 ,000 employees and puts it down to a handful. but you don't actually need crypto assets to have blockchain technology do you you can have a distributed ledger anywhere and you don't need bitcoin for that you just need the technology and you want it to probably be interchangeable across different players in the spaces you don't want goldman to have their blockchain and jp to have their blockchain you want one blockchain everybody uses defi itself we're still struggling to find the way applications you know there's some headway in gaming there's some headway where it's kind of interesting apps that people will actually use.

22:02But a lot of it remains stuff we speculate on because it's fun. I did watch the hamster races a few weeks ago. They were great, but they were not a life-changing technology in DeFi. But hey, people like to gamble on weird stuff. ED HARRISON It is so interesting when you mention this decoupling of decentralization blockchain technology from some of the coins that we see today. Obviously, this is a very controversial statement. One of the things that decentralization has allowed is this decoupling of the nation state from the money supply in a way that was just simply not possible before, I guess, sort of absent some sort of a gold standard.

22:39And that's something that excites a lot of people in the space and that many people are very passionate about, particularly in the Bitcoin community. But as you point out, whatever the sort of merits or attributes of that, it isn't necessarily intrinsic to the way that decentralization works. And I guess one of the major questions that I have, at least as I look across the space, is what happens when we do start getting CBDC, central bank digital currencies, or a treasury coin? In other words, something that's issued by either a nation state or a central bank, how does that impact the state? That is, for me at least, probably the biggest single wild card as we look out across this space today.

23:17Yeah, I think the concept of them is really exciting CBDCs and digital treasuries and, to a certain degree, real-world asset tokens. Those are all exciting things. But to the extent you have a centrally controlled CBDC, you can get coins blocked. You can get blacklists. And this is not something that decentralized crypto purists like. So I do worry. It's kind of the powers that be co-opting our little revolution here of what money is and how it's managed. So while it'll be cool to have cash that's not physical, I don't think it's great for crypto. I think it's probably a net negative. RAOUL PAL Yeah, I think that's very well said and very well framed.

23:59Let's shift gears here from the strategic to the more tactical. What's your outlook on the space for H2.23, the second half of 2023? RON GOOPER You know, I don't think there's a reason for things to get loud again. I think things will remain quiet. What I'm hoping for, though, is that things remain quiet in a good way. We had all these blowups last year with Luna and FTX, and we had the bank seizures earlier this year. And we just want things to be quiet, because crypto's reputation has been battered. There's no arguing that. And the best thing for it is for the surviving and remaining actors in the space to remain good actors.