How Is a Hedge Fund Navigating This Crypto Minefield?

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2:31Welcome to Real Vision Crypto Daily Briefing. I'm Ash Bennington. Today, I'm joined by Chris Sullivan and Chaim Bodek, both co-founders and co-portfolio managers at Hyperion Decimus, a digital assets hedge funds. Welcome to the show, guys. Thank you. Thank you. Appreciate it. Oh, man, this is a big show today here on a Friday, a lot to talk about. Let's start out with a little bit of news flow. It's NFP Day, nonfarm payrolls. A couple of charts I want to show you here. The first chart, chart one, monthly change in jobs. Once again, the print came in hot in April with 253 ,000 new jobs added. It's a big beat with Wall Street estimates coming in at 180 ,000 new jobs added.

3:12The chart that you're looking at right there probably tells the story best. You can see those job numbers tailing off and now spiking up again. That's the most recent month on the right there in orange. Adding jobs is obviously a good thing for workers, but it puts the Fed in a real bind, particularly with everything that's happening right now in the regional banking sector. Let's take a look now at chart two hourly earnings versus CPI. This may look a bit like a Goldilocks scenario when you see inflation rolling over and the increase in earnings from the pandemic lows. But it is definitely not.

3:48While inflation is broadly declining and wages are rolling over a bit, inflation right now is still 2.5x, the Fed's target. We're looking at CPI here, not the preferred target that the Fed uses of PCE, that's personal consumption expenditures. This is consumer price index. But you get the general gist of it from this chart. I'm going to quote from the New York Times here. Average hourly earnings climbed 4.4 % in the year through April. That's compared with 4.3 % from the previous month. So again, it's up and was more than the 4.2 % that economists had expected. So it's a beat. It's up on the prior month.

4:21This obviously is putting the Fed in a difficult position. They may, repeat, may be between a rock and a hard place over at the Fed right now. Essentially, what you have is more actively employed workers and accelerating wage growth. That means increasing inflationary pressure at a time when the Fed wants to put rate hikes on pause because of the instability that we're seeing in the regional banking sector. So it really is a challenging and tricky time right now for the Fed. That said, I want to switch gears here and take a look at what's happening in the digital asset space. Bitcoin on the day, it's up 2.3 % on the last 24 hours and seven days.

4:58It's up around 1.3%. So for Bitcoin, not a whole ton of activity. Ethereum, 5.6 % on a trailing 24-hour basis, seven days. It's up 5.4%. I don't know. Do we even want to do this? Do we want to look at Pepe? Pepe obviously has been absolutely mooning here. Anytime there's a chart with five leading zeros, I get a little bit suspicious, but you can draw your own conclusions from that. It's up 125 % on a trailing 24-hour basis and it's up i don't know 1400 uh over the last seven days i'm not sure what the use case for this thing is but uh it's certainly flying uh upward here in terms of price uh let's get back to our guests guys i'm really excited to talk to you guys there's so much happening uh let's talk a little bit about where you think we are right now and for folks who don't know tell us a little bit about what hyperium decimus does sure we're a multi-strat that's quant driven kind of in the og category for vintages of hedge funds in the space.

6:00And we just combine a portfolio of fundamental conviction names that we hold for long term and look to accumulate more with, you know, differentiated and non-correlated quantitative and systematic strategies so that we're kind of smoothing out the volatility of the space over time and kind of live in between drawdowns and not over you know over leverage our skis on the upside we actually don't employ any leverage within the fund which has helped sustain our returns over time but um definitely always our underwriting projects both in the d5 space and the l1 l2 space are up to speed on all of the roll-ups and different types of technologies that are rolling out that can batch and combine and staking and restaking.

6:48So always underwriting new concepts, new tokens, and we've really had an amazing time in this space. Yeah, you guys are really OGs in this space. I know we're going to talk about what's happening right now from a legal, regulatory, and compliance front here in the US, but this bears on your experience, on your background, what you guys have both done in this space in terms of participation, in terms of whistleblowing, in terms of a lot of different things. Talk a little bit about that. But, Chaim, why don't you jump in and give us a little bit about your background as well? Well, I started out in the options industry, and that was in the late 90s.

7:24And I took the straight route for quite a large part of my career. Ended up running global option market making at UBS Investment Bank, and then jumping out to start my own high-frequency option trading firm in 2007. 2011, I took the path, you know, the road not traveled and I became an SEC whistleblower. I since then, you know, we launched the fund in 2017 and I do a lot of other things. But in terms of like whistleblowing, I have been active with probably at least 20 investigations over the last 12 years with the SEC, awarded two major multimillion dollar awards for the work. And I'm, you know, my first major whistleblowing experience was turning in undocumented features that were used by high-frequency trading firms.

8:34And Direct Edge, which was owned by BATS, was fined$14 million for those. So I was completely vindicated on that. The work I did then resulted in over 500 pages, according to Stan, our regulatory officer here, over 500 pages in the federal registrar where exchanges were forced to disclose features that they had provided high-frequency traders and didn't really tell anyone else about. up. So that was a major contribution in terms of the evolution of U.S. market system that I'm known for. I think I'm in four documentaries on this. There's a book written about it called Dark Pools. I've written two books, The Problem of HFT and the Market Structured Crisis.

9:29Probably HFT actually became a lawsuit that went all the way up to was actually appealed to the Supreme Court. So I've been in the trenches for a long time with regard to how market structure operates. When it comes to market structure, when it comes to regulation, you guys have been there and been doing this for a very long time in the TradFi space, in the options space. Just a lot of experience that you bring to this, which is why I'm so curious to get your view on what's happening right now. What's happening in digital asset markets? How do you see this interaction between the markets themselves and the regulatory structure that is meant to, in theory, protect customers, create capital accumulation, and form orderly rules of the road?

10:13Where are we with that, guys, in your view right now? I thought things would be better by now. I've been, as I said, I got into the market reform role because my firm was a victim back in 2011. We have a more complicated, more fragmented market now. And in terms of regulatory coherency, I think it's actually been eroded, especially in the last few years. If you want to talk about crypto assets in particular, one of the things that has been a problem is the uncertainty in terms of what regulator is actually in charge of these markets. And, you know, we've been operating with the view that the CFTC has put forward that the vast majority of crypto assets are commodities.

11:21And, you know, there's actually things on the CFTC has actually given statements saying that. And now more recently this year, the SEC is, you know, taking this novel approach that their statement is that the vast majority of crypto assets are securities. And you probably saw the headlines on Coinbase being in the crosshairs of that, you know, the evolution there in terms of regulatory position. Yeah. In fact, we just spoke with the chief legal officer of Coinbase, Paul Graywall, earlier this week. Of course, they had reserved a Wells notice by SEC for precisely that point. So in terms of regulatory ambiguity challenge, whatever you want to call it right now, we're right in the thick of it.

12:14We're in the actual center. Now, if you go back in time, you have the. What you have in the U.S. is really interesting for me in terms of whistleblowing. And what I learned very early on is there's there's actually a competitive environment among regulatory agencies. So, you know, I have been either working directly with or been interviewed and consulted with the CFTC, the SEC, New York Attorney General, the DOJ. And, you know, I even met with the FBI at one point. And what's interesting is they don't coordinate as much as you would think. that they do. And often they will directly compete. At one point, I was actually told by a person at New York Attorney General that they see themselves as competitive with the SEC.

13:17Now, there is actually, at first I thought that was not great, you know, having this. This is the New York State Attorney General, the state law enforcement chief's office here, not the U.S. Attorney's Southern District of New York, where a lot of this takes place. I know this gets confusing for a lot of people, but this is really a very sort of complex patchwork of regulation and enforcement that we're looking at. And we're trying to unpack it here with folks who are really experts. So what happens is if one agency, let's say the SEC, does not pursue, let's say, an enforcement action that is valid.

13:53And this has happened. This happened with the dark holes. The New York Attorney General moved first. Interestingly - By the way, dark pools for people who may not know are pools of securities that are being traded where the block size and the holder of the securities is not known so that they can be matched up in theory with less market impact from knowing who you're trading against. Right. So what I'm saying, looking at it from one angle, the competition between regulators at times can end up making the market better because one regulator may step up and take action in legitimate scenario where the other has decided not to.

14:38And I gave an example of the dark pools. So you already, you know, you definitely see that because we have with the crypto assets, because we've had every regulator that has, that probably I think everyone I've mentioned has had some action in the crypto asset space. The problem really is when the regulators basically push interpretations of the rules, and that's what the SEC is doing now, it's a huge deal if crypto assets get reclassified from one asset class to another. Just think of the tax obligations of that, for example. And to that point, just to double click on it and to make this point clear for people who are relatively new to this, you said earlier that CFTC has made statements that obviously contradict the statements that have come out of SEC.

15:46But just to give you a sense of just how codified this is, I want to read some language from a complaint filed by CFTC against Binance. Again, Binance has a chance to respond to this. I'm just using this as an example of the way the framework that CFTC is using. It goes on to mention here Binance and CZ directly. And then it says, quote, has solicited and accepted orders, accepted property to margin, and operated a facility for the trading of futures, options, swaps, and leveraged retail commodity transactions involving digital assets that are commodities, including Bitcoin, BTC, Ether, ETH, and Litecoin, LTC.

16:25for persons in the United States. So this isn't a junior staffer speaking at a conference and making reference to these assets being commodities. This is actually in a formal complaint that CFTC has filed saying, in fact, these are commodities. Now, if you go over to the other side, SEC very clearly in their Wells notices, in their public statements has made the implication or the statement that, in fact, they are securities. This is a very confusing time for anyone in the United States who wants to operate in this space, who wants to be a good actor, and who wants to remain in compliance with all the relevant federal, state, and local regulations and laws.

17:07It is a very tricky business. Yeah, not only is that, but the application and then the narrative, right, has rotated in the five six years we've been professionally doing this multiple times right and just what you pointed out that's just in the in the recent you know last few months where but you're you're claiming and asserting a wrongdoing but then classifying the assets that were part of the wrongdoing while the other regulator is taking the opposite position and our arc sort of ethos has always been all right let's let's assume securities laws and bags let's assume commodity laws and regs what are the differentials and how do we best prepare to be compliant with both in either scenario and then here it's like well do we just ping pong back and forth and then the lawyers the lawyers don't know what to say and you can have we actually have three outside counsels our chief regulatory officer is a jdmba so you know everybody's opinion going forward and then the analysis has been kind of sort of retraded for lack of a better phrase multiple times in the last few years and especially last 12 months our concern is that you end up judicially litigating a lot of these issues instead of clarifying with nomenclature and semantics which i think you know the position of the space should be let's not be combative let's use this as an opportunity to be further transparent in the ethos and mantra of the space and show and prove that, hey, we are already in compliance with ABC under the CFTC.

18:46We are already in compliance with XYZ with the SEC. Please let us know where we're deficient and give us a reasonable period to improve or eliminate those deficiencies. That's it. And everybody plays well together. That being said, none of the concerns that we would have as investors or business owners have been assuaged by any of the current actions or lack of action, whether it's supervisory or consumer protections, which to me rings true the most, because as long as consumers are protected, then if the big boys and girls lose money, who cares? They can bet whatever side they want. And in fact, one of the reasons we've probably seen this upswing in regulatory and enforcement action is because retail customers in the United States got hurt around FTX.

19:37And it is a real challenge. Listen, to exactly that point, guys, I want to bring this conversation up to a level where folks who are out there in the retail space who are thinking about this can have some takeaways and try and understand it. You know, guys, what you're watching right now, this is the real deal. This is unfiltered. You've got two OGs in the hedge fund space who are telling you what's actually happening on the inside. I know this can be a little bit complicated, but the reason for that is that we are actually looking, we're drinking from the fire hose here. actually getting to what's really happening in this space, which is why I'm always so appreciative when both of you guys come on the show.

20:07So what should people be taking away from this conversation who may have never been in a room with guys like you who work at a hedge fund who actually think about how these markets work, think about the legal and regulatory implications? What should they be taking from this conversation? Well, one of the things, and I'm not really happy to say this, but the regulatory uncertainty is acting as an impediment to true adoption by institutions in large scale. In a way, this issue, regulators are supposed to come in and provide clarity but like they're supposed to come in to protect markets and make them more investable and this turf battle in crypto between different regulators and the uncertainty and then also you know basically creating policy through enforcement like like you know for example on that Wells letter.

21:14These are things that are bad for the space and bad for retail because you want markets to have lots of liquidity and you want there to be a lot of edge in there. What we're seeing is a lot of fragmentation. We're seeing a decline in liquidity and we're seeing a more dangerous trading environment. And so I would say that retail should be looking at this as a danger to the market. And to the degree that things are not resolved, be careful out there in the marketplace. A danger to this market. And I want to just underline this because I know that there are probably a lot of people watching this who have never had the, oh, I don't know, shall we say pleasure of working at a bank.

22:06What you're saying, hi, if I understand it correctly, is that these are significant headwinds. What winds up happening is the folks in the corner offices who work at banks, as we all have on this conversation, someone walks in to the office and says, hey, man, I want to trade crypto. Let's make markets in this. We want to do some cool stuff with this. And the guy or gal who's sitting in that corner office says, are you kidding me? I read the Wall Street Journal. Why do I need this misery in my life? There's no clarity here. This is going to wind up pulling me into depositions and lawsuits and conversations with regulators that I just don't want to have right now.

22:39I've got a business to run. And this, as you say, if I'm understanding correctly, is a significant headwind and a risk to price because there is an absence of liquidity, depth to the markets and institutional adoption. Well, Ash, it does work both ways on price, right? So I think the main takeaway is the adoption, right? Right. Because, you know, as U.S. citizens and believers that U.S. rule of law is the shining beacon of actionable fact, right? And our court system, at least historically, has been a good arbiter of that, maybe not so much recently. But I think now you've seen examples like the Liechtenstein bill that went first to really focus on segmentation and taxonomy and categorization, and the MECA bill that came out of Europe.

23:33Those are legitimately reasonable proposals based on the differentiation of assets. And not only do we risk economic and jobs and business formation in the U.S. by not collectively setting standards and rules and procedures, but we also are alienating a massive innovation marketplace globally, a massive philosophical movement for decentralization, which literally is just going to push it overseas. And that's the issue. I mean, Coinbase has said that publicly, they just launched a new exchange overseas. So did Gemini, actually. Yeah, in a way, as statements that this... And they're regulated by, I think it's the Bahamas Monetary Authority that's regulating the Coinbase overseas exchange.

24:26By the way, U.S. residents, U.S. persons are not able to trade on that exchange. They are excluded from doing so by U.S. law. Exactly. So this issue is impacting everybody, actually. And what you just said earlier about institutions being on the sidelines, when we started this fund, it was directed and continues to be directed to satisfy institutional investor needs. And what we have seen over and over and over is the fits and starts. The environment looks good. The interest is there. And then something in the crypto space stops the interest and makes people defer investment. And FTX was that.

25:23But what we didn't expect, what I didn't expect, is the regulators to create more uncertainty after FTX. Right now, you look at it, and not only would an institutional investor be worried about another FTX-type situation that could destroy capital and contaminate markets, but we're now looking at the regulators as a risk. This is the first year I'm looking at the regulators as literally a risk to the crypto marketplace. That's so interesting. I would just say, like, flat out, I do not see any of the regulators who are named here as showing the competence and care to actually develop this market, right?

26:11I mean, the SEC is with equity markets, with their mandate, they have a dual mandate to enforce laws and protect customers from harm or market participants from harm. But they also have a mandate to protect the health of the markets in terms of fostering economy. What we're not seeing from these regulators who are doing land grabs for digital assets is a care to help nurture those markets. In my personal position right now, knowing very much, so much about how markets are regulated by the SEC and also with the CFTC, how they regulate spot markets and commodity markets. um and i look at both of those and i'm like you know what they're not those two agencies are not qualified to regulate this space i i think there should be and you know go for it i'll just say it out loud right i think there should be another agency i do not even think the agency could be a subdivision of of you know cftc or sec um because uh you're talking about creating a whole new agency for digital assets in your view that would be the best thing for these markets uh absolutely and and just just in the same way that crypto assets or digital assets were designed with the intent to kind of replace the old order and to create a new economic system right i don't actually think at this point in time looking at how the actors are or you know how the agencies are acting, I think you need to see the same thing with regulation, a complete from the bottom rethinking and redesign of the regulation with regard to digital assets.

28:18And I want to read this right from the SEC's website in terms of what their mission is. The SEC's longstanding three-part mission is to protect investors, maintain fair, orderly, efficient markets and finally to facilitate capital formation and that goes on to say that remains their touchstone uh there is a real question right now in the minds of many investors many participants in this community and in this space about whether they are in fact facilitating capital formation right now i mean they absolutely are not and it's not the position of the digital asset and crypto space to be adversarial right most most of the you know long-term advocates and long-term developers in the space, they're not even conscious of this dynamic, right?

29:01They're focused on code, new economic systems, the metaverse, the Web3 development, the DeFi side. Like, they're focused on building and allowing for this, you know, improvement and increasing of velocity of money. Like right now, if you pull up that chart, Ash, it's like, and that's 100 % correlated to the wealth divide, right? As velocity of money goes down, wealth divides further and instead of of fostering or even just applying the existing rules and regs which really in my eyes have never prevented calamity anyways so unfortunately for all of the taxpayers of the u.s like even though we fund these organizations they've not prevented and we're honorable commerce 08 or 87 89 savings and loan or even what's going on right now with the banking system.

29:51I mean, it's laughable. No one's paying attention to duration mismatches, or we got a fake mark to market at a hundred cents of the dollar because you're bankrupt. I mean, it's just. Yeah. And now, by the way, you can just pick up your cell phone and move money in 45 seconds to another bank that you believe is going to be better backstop. Maybe it's a G-SIB. So there is this sort of rising risk coming with the technology. And of course, the cyclical story of rising rates. By the way, if anyone wants to take a look at the chart that Chris is referring to. It's the velocity of the M2 money stock.

30:20That's M2V on the FedFRED database. Guys, I want to jump in here because we have, and I know this sounds like a line, but it's true. We've got the smartest viewers in the space. These questions are always unbelievably great. And I want to get to some of these questions because our audience is very sophisticated on this. This first one comes to us from William on the Real Vision website. If the SEC were to get its way and ETH were declared to be a security, what would be the worst that would happen to ETH since brokerages of ETH would simply migrate to, say, the UK? If the SEC were to prevail, could ETH simply comply and register as security with little harm to investors?

30:56What an interesting question. Yeah, that's like 15 questions in one to unpack. That's a real question, man. That's what we expect. So theoretically, the registration and the requirements are easy. You hire securities council and you show like what what you fall under as far as is it investment contract is there an expectation of profit yada yada yada uh but but it's already a commodity it's not debatable 100 of issuance is out there it burned thousands it burns thousands almost every day it's almost every day deflationary so it to me it cannot be argued on the merits that it's a security where where you could get the delineation is those that are offering it separating exchange and broker dealers and and semantically identifying that and saying that here's an offering of an investment contract through this vehicle or product that does constitute an investment contract therefore as a security but as far as like the eith founders and foundation and community like going through that process i i think they would obviously be willing to do that.

32:04But there's just no way that it's a security. I'm just not even sure how you could have a registration for a decentralized digital asset like ETH. I just don't, and I'm not being critical here. I'm just trying to get my head around how SEC regulation would apply to something that's run by a foundation and not a board of directors, not a company, not a traditional corporate structure. It's just a really hard thing to understand. Well, it's not a for-profit an operation either. I think the question is also to what end, right? And this is basically just interference in the growth of the asset, right?

32:42I think one place in terms of microtransactions, that type of constraint, I mean, can you imagine if we had to, if, you know, a regular like PayPal, We had used PayPal transactions all of a sudden were deemed securities. And how would the market operate if payments went to securities? Well, that's exactly what they're saying. They're saying that these crypto assets, digital assets, which are so integral to payments and micropayment systems are securities. And that puts it into an entirely different jurisdiction where most institutions are not registered to handle them.