#1032 - Are Crypto Markets at Risk? ft. Jeff Dorman | Ethereum, Bitcoin, and the SEC

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0:38Are crypto markets at risk? Welcome to Real Vision Daily Briefing. It's Wednesday, May 8, 2024. I'm Ash Bennington, joined today by Jeff Dorman, Chief Investment Officer and co-founder at ARCA. Jeff, welcome back to the show. Thanks for having me back. Well, it's a pleasure to have you here, Jeff. I have to say just right at the outset, I've really enjoyed your writing recently. That's our two Satoshis. Talking about what's happening in crypto markets, you managed to do something that is very difficult to do, which is to take all the data points, all the news flow, which is coming fast and thick right now, and arrange it into a narrative that makes some coherent sense.

1:15Really appreciate your work. Talk a little bit, Jeff, about where you see us right now in crypto markets. Sure. Well, first of all, I appreciate that. Look, I'm as constructive as ever on the crypto markets. I don't think anything has changed there. Probably the biggest change versus expectations, at least in crypto, was just slower than expected inflows into the industry outside of Bitcoin. Typically, when you see the type of return set that we saw in 2023 and thus far in early 2024, you see a lot more money coming in. I think maybe underestimated either how badly burned some investors were by 2022 and or just how difficult it is to push allocations through an investment committee or through a board.

2:04But within the walls of the digital asset industry, there's really nothing not to be excited about right now. Sorry for the double negative there, but really it's exciting. We're seeing a similar setup to what we saw three or four years ago, which is real projects emerging, real and new sectors emerging, similar to 2020, 2021, when all of a sudden we had DeFi and stable coins and NFTs. Now you've got real world assets and you've got Bitcoin layer twos and ordinals and runes popping up. You've got AI and gaming. So it's a really nice setup, not to mention the macro setup. So pretty exciting. I think the big challenge as always is just the narrative, right?

2:46Can we separate what's actually happening from all of the noise and the fluff that's out there trying to either confuse or distract from what's really happening. It sounds like you're really quite optimistic, quite construction on the underlying innovation that's happening in this space right now. Talk a little bit about that. Yeah. Well, I mean, look, I think this is an asset class that may actually not even be an asset class anymore. And I say that purposely because I often make comparisons to the ETF market, right? You would very rarely, if ever, find someone who would say, I can't invest in ETFs right now because I don't believe in that asset class.

3:27People would be like, well, what are you talking about, right? Are you talking about the commodities part of ETFs or the equity part of ETFs or fixed income or actively managed ETFs? What does that mean, right? It's very easy for people to compartmentalize that the ETF is a wrapper or a structure and lots of different things fit into it. 10 years ago, and even as much as seven years ago, the crypto and blockchain world really was just sort of currencies, right? And that's all anybody thought about. But now, it's everything. You've got currencies, you've got commodity-like assets, you've got asset backs and equity and bond-like assets, you've got meme coin, you've got all these different sectors from gaming and AI and all the things I mentioned earlier, DeFi.

4:05It's really hard to just put crypto in a box. And yet that's constantly what is being done. It's constantly crypto is uninvestable or crypto is a great asset class, or you have to be involved or you can't be involved. And it just doesn't make any sense. There's parts of crypto that make all the sense in the world. There's parts that don't, but it's just grown tremendously. And in terms of your question about what's exciting, like, yeah, there are parts of the industry that are really growing. I mean, stablecoin growth is incredibly impressive. The ability to have all these different chains now supporting DeFi applications in layer twos is really impressive.

4:42The amount of games that are going to be launched in 2024 and into 2025 that have been worked on for three or four years is really an impressive suite. And it's probably going to be the next on-ramp into real consumer adoption. Some of the D-PIN applications, even if maybe price of the token in some cases is ahead of the fundamentals of the project. These are real projects touching real people where a lot of the end consumer doesn't even know it's being run on a crypto rail. So that development is real. And again, it's really hard to look at like Bitcoin and D-Pin and gaming and put them in the same bucket.

5:16They just, they aren't, right? In the same way that, you know, you wouldn't bring a long short equity manager on to talk about gold. You know, you shouldn't bring on somebody who's focused on different niche sectors of crypto and have them just talk about Bitcoin. It just doesn't make sense. They're totally different, just happen to be packaged in the same wrapper. Yeah, that's really interesting talking about this. That's a significant conceptual shift, I think, from the way a lot of people perceive it, which is, as you say, as an asset class. But essentially, what you're saying is, what if this is more of a technology-driven revolution, where you start to see all of the existing traditional capital market structures moving on to digital asset decentralized rails, probably plus new applications that don't work or don't make sense under traditional capital market structures are a really interesting concept.

6:05Yeah. And in fact, I even purposely don't use the word revolution and instead use the word evolution for that reason. It's not necessarily that we're recreating or that we're creating anything new. A lot of cases, we're just repackaging or recreating it in a way that just makes more sense, right? It's a natural evolution of finance. It's a natural evolution of gaming. It's a natural evolution of payments and the way to think about asset transfer and collectibles. So to me, it's more evolutionary than revolutionary. Interesting. I want to shift gears here a little bit and talk about maybe if we were thinking about digital assets, crypto in a different context, more of a is currently just a risk on asset or super asset class.

6:48I wanted to take a look at a clip to just talk a little bit and set up a little bit of the broader macro context right now. This is from a conversation that actually I had with Tanya Reif, Martin Leibwinder, and Brian Dixon. Let's take a look at this clip real quick, and then we'll get your reaction to it. First, we had geopolitical tensions. That's always problematic for asset markets. We had Iran, Israel debacle happening early in the month, somewhat mid-month, first from the Iranian side, then from the Israeli side. All the uncertainty that brought to the markets was not good for asset prices.

7:26But in particular, also, it pushed oil prices higher. And we have had three months, three consecutive months, where inflation had surprised to the upside, pushing rates higher. And then on top of that, geopolitical tensions are pushing oil prices higher, and that's adding to the pressure on rates. So we had the geopolitical tensions adding up to oil prices and the rate outlook that was making markets very nervous. Higher rates are, of course, not great for liquidity. And as we know, for crypto assets, liquidity is of paramount importance. So then again, on the liquidity side, outside the rates outlook, we also had a little bit of an air pocket in liquidity like Michael Howell likes to call it.

8:17And the reason is we had a pullback in the U.S. because people were paying their taxes. So the TGA actually rose mid-month by April 15, which was a tax deadline, and that pulled liquidity out of the system. And on top of that, we had other central banks, most importantly, China, that had also pulled back on their liquidity injections for the month. So you had, if you will, a combination of a perfect storm between the tensions, the rate outlets, and the liquidity cycle all coming together. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

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10:00Well, you see Tanya Rive coming at this from more of a sort of cyclical perspective rather than the broader secular structural context that we're talking about. But she mentions a couple of things in terms of global macro headwinds. First, geopolitical tensions, the impact and risk to oil prices and potential rate outlook, the air pocket in liquidity, and also China pulling back on their liquidity. Jeff, thoughts? Yeah, I mean, there's a lot to unpack there. And I think, you know, I've been one of the advocates of crypto's uncorrelation or non-correlation to traditional assets and macro over the last decade.

10:38And of course, 2022 threw that for a loop because everything went to correlation one, basically because you had a four or five sigma change in terms of rate expectations and rate hikes. We went into 2022 expecting three cuts of 75 basis points total and, of course, ended up with, what, almost 400 basis points or over 400 basis points of hikes instead of just 375. So when you had that kind of a move, everything went correlation one. You also had, obviously, the bankruptcies that infected it in crypto. So you started to build this narrative that, hey, crypto is just sort of a risk-on asset class and it's going to get hit just like anything else.

11:11And it's just not true, right? The data over seven or 10 years or even three years shows that this is a pretty uncorrelated asset class. So while we look at these macro factors, and they certainly can matter at times, they don't always matter. And specifically with what was mentioned in that clip, you know, the Israel-Iran conflict was really interesting because the initial knee-jerk reaction on the very first Iran headline, Bitcoin actually went higher with gold. And then on every subsequent headline, it started going down and ultimately led to liquidations and cascations and led to momentum traders and pushing everything down.

11:45And it's hard for me to say in a vacuum if there weren't other factors going on that that alone was going to be negative for crypto. In fact, there's no real historical evidence that wars in general really have any sort of long-lasting effect on equity markets or crypto markets. Certainly, there's no empirical data that suggests that oil prices have any real effect on crypto prices. But what I will say is that the liquidity is real, right? When you have periods of increased liquidity, global liquidity, that is obviously good for all risk assets because it increases the flow of money. It increases the riskiness of sitting on cash and the opportunity cost of sitting on cash.

12:27And it does for sure affect markets. What I would point out specifically, though, to the Israel-Iran conflict is that there were a lot of other factors going on that, in my opinion, were by themselves not necessarily impactful enough to push the digital asset market down, but collectively were enough. And the Israel-Iran conflict was really just a trigger that pushed selling to a level that created everyone paying attention to these other things. For example, the higher than anticipated inflation prints in April, which resulted in a reduction of the expected Fed rate cuts this year, a slowdown in the Bitcoin ETF inflows, the assumed rejection of the upcoming May Ethereum spot ETF, Uniswap receiving a Wells notice from the SEC, some unsustainable meme coin advances and money kind of chasing that from a FOMO standpoint rather than investing in real projects.

13:18Solana even had some performance issues with their blockchain for the first time in, I believe, over a year. And then, of course, the tax day in the U.S., which, again, there's no real evidence to suggest that you know exactly which way this is going to push flows. But there's certainly a one-time impact on the U.S. tax season. So when you put all those things together, that's a shift from a positive sentiment to a slightly negative sentiment. Again, I don't think any one of those by themselves was enough to push crypto over the edge. When you put them together, that's enough to change sentiment.

13:46And in my opinion, the Israel-Iran conflict and oil prices was, again, just a trigger that created some algo-driven selling, which then turned it into, OK, momentum trading is going to push this stuff and we're going to start focusing on the negatives rather than the positives. Obviously, a lot there and very well said. A lot of points talking about where these markets are. I want to zoom in on something that you mentioned that I think is so important. And it's the topic of a recent blog post that you wrote. That's our two Satoshis. By the way, if you're not reading this blog, you should be. You can go and find it up on the ARCA website.

14:20But this is a blog post called Crypto vs. the SEC. The title says it all. There are actually two parts of this. We'll unpack both of them. But let's focus on the regulatory component here, because you do a real deep dive on everything that's happening in the space. You present an overview, and then you drill down into all the individual cases, the precedent. A really impressive analysis here. Where are we right now with the regulatory environment for digital assets in the United States? Sure. I think the regulatory overhang is definitely real. And when we talk to investors all over the world, and we have a nice business development and IR team in addition to our portfolio team here at ARCA, where we're constantly traveling and talking to investors, over the course of seven years now doing this, there's always been some constants with regard to the pushback we get on crypto, and there's always been some new things.

15:10Two of the constants were always, how do you value this and regulation? The regulation issues with investors was incredibly high after 2022, to the point where it was just a non-starter with a lot of people. And that veil was lifted almost immediately when BlackRock announced that they were going to enter the Bitcoin ETF space. It was unbelievable, just like night and day, where investors could no longer use that as an excuse. They basically said, OK, BlackRock's involved and we're not able to use this as an excuse anymore. But it wasn't just BlackRock getting involved, or maybe it was the spark, but you started to see a real pushback from companies and projects in this space who were for the first time willing to take the SEC on head on.

15:58For example, you had Ripple Labs versus the SEC, and you had the U.S. District Judge Torres basically saying that Ripple did not violate federal securities law by selling its Ripple tokens. That was sort of unique to just Ripple, but it definitely had a Ripple effect on the next wave of SEC fights, which was Grayscale winning a court order against the SEC, in which the SEC was deemed as being arbitrary and capricious, which many believe was actually the final straw in allowing the Bitcoin ETFs to be approved. Then the SEC got a big win versus Coinbase, but the Coinbase wallet itself had a triumph over the SEC allegations, which was a giant win for DeFi, basically, which led to Uniswap now feeling more comfortable turning on their fee switch.

16:42Now you have consensus joining the fight. The new wave, which I had never seen before in my career, is usually if you get issued a Wells notice from the SEC, you don't tell anybody. You're kind of quiet about it now. It's like, hey, we got a Wells notice over here. We want to let everyone know we got a Wells notice, and we're going to fight it. Let me read this. This is a quote right from the newsletter where you're quoting Joe Lubin, because I think it gives a sense of the temperature, at least as it's perceived right now by the founders in the space. I want to read this. This is, again, Joe Lubin from Consensus.

17:10Quote, we took this step for two very basic reasons. One, the SEC should not be allowed to arbitrarily expand its jurisdiction to include regulating the future of the internet. And two, the SEC's reckless approach in bringing chaos to developers, market participants, institutions, and nations who are building or are already managing critical systems running on Ethereum, the world's largest platform for decentralized applications. I think the one thing that's notable about this is, and this is the point that you were making, if you've spent time in the traditional finance space, you do not see CEOs of large investment banks publishing blog posts that sound like this and taking action against SEC.

17:46It's just something that's not done. So it is interesting when we talk about the temperature in this space, the way the space is being perceived. It's a pretty extraordinary moment. It is. It's extraordinary. I mean, I've been in this industry or in finance industry now for almost 25 years, I didn't know the SEC commissioner names until recently. It wasn't something that you cared about. I mean, you feared the SEC from a respect standpoint. You feared them from a law abiding standpoint. You certainly listened to your compliance officers and made sure that you followed the law, but you didn't care who was actually in the seat.

18:16You didn't think about them in any meaningful way. You certainly didn't challenge them in this open way, which is again, Again, it's a continuation from BlackRock getting involved to these little recent minor wins. And you can see, again, this sort of ripple effect of, oh, we're going to fight this. And we have a chance of really winning. And a hat tip to all the larger, well-capitalized firms and crypto out there who not only have the willingness, but also the means to be able to fight this on behalf of the industry. I actually had a, we were lucky enough to have a meeting with Hester Peirce recently.

18:53I think it was at the end of last year, maybe beginning of this year. And one of the things, of course, for people who don't know, is an SEC commissioner who's been very pro-crypto and has been critical of some of her colleagues in the SEC in regard to their handling of crypto regulation. For sure. And we had a great meeting with her. And the one thing that stood out is she mentioned the reputational damage the SEC is taking right now, not just from crypto, but across the financial industry, in the sense that, again, the SEC would probably be better off if nobody talks about them, certainly would be better off than everybody talking about them and is certainly in a negative way.

19:34And that's real problems, right? When you think about any sort of revolutions in the world or any sort of, you know, David versus Goliath type stories, that's what it starts with. It starts with, hey, these guys are overstepping their bounds. Maybe we didn't really know about them before, but now we do. And then there's a cohort of people who are just like fed up with it and really fight back. And again, this is not broad based against the SEC or any particular actions. Um, we're simply pointing out that there is a cohort now of businesses that are well capitalized and have the means to push things forward where you're going to have real clarity, uh, uh, coming to this industry, which, which, you know, every project, uh, founder, every investor, um, every intermediary in this industry has been dying for, um, you know, it's kind of like, uh, you know, when I say, you know, I didn't even know the SEC commissioner's names years ago.

20:26I mean, it's kind of like a good ref or a good umpire, right? It's probably not great for anyone when they become the story. So, you know, we'll see if some of these actions have big sweeping changes to the actual law, as well as again, just a massive shift from this sentiment overhang to now a positive sentiment. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing. Well, it is interesting. When you cover the story, you have to try and remain neutral about it. But it's just an extraordinary moment. If you're new to this space, if you're new to financial services, if you're new to following regulatory action, for example, this is just very unusual.

21:10This isn't something that you see. Jamie Dimon does not publish blog posts like this. I mean, you saw it this week as well, or this week, I believe, when Robin Hood got the Wells Notice. I mean, barely even a blip. Nobody cared. I mean, a Wells Notice used to be a really big deal. If you get a Wells notice, it was like, oh my God, like something bad is happening. Robinhood gets a Wells notice. They immediately tell everyone, say, we're going to fight it. Coinbase jumps on and says, we got your back. And the stock barely moved. There was no ripple effect in the market. That's incredibly different than what it used to be like if you had any interaction or call out from the SEC.

21:45Yeah, very interesting indeed. The other thing that you write about that's really interesting that I think it would be great for our viewers to be able to listen in on is your view of the challenges in the space right now in terms of the potential misalignments between digital asset creators, founders on the one hand, and their investors on the other. This, I think, is really interesting. And you're sort of uniquely positioned to talk about this because of your prior life in investment banking. Yeah, I mean, I started my career as an investment banking capital markets employee at Lehman Brothers and spent a lot of time with new issues and M &A from the fixed income and the equity markets.

22:24So I definitely, you know, have seen the way it's historically done in traditional markets versus where we are today. And, you know, not to pile on the SEC stuff here, but I mean, there's definitely, that is definitely part of why and how new issues in the token market are being delivered the way they are, because the SEC has so many lawyers and project founders and exchanges living in fear in terms of how to actually issue and list a token. But that being said, there's still things that are, in my opinion, just being done completely wrong. Not just different, but flat out wrong. Because there's just hundreds of years of evidence of how to do it right in the debt and equity market versus what we're doing in tokens.

23:02And - You're talking about now the actual structure of the tokens and the way the relationships the investors, not the regulatory. Correct. Right. I'm talking about the structure of the tokens, but also just the listing process. So to back up for a second, right? We had 2017, we had ICOs. ICOs was basically, we're just going to spin up a website, say, we're going to issue this token and anybody can participate, retail or accredited investor. You'll get your tokens and we'll see what happens, right? Ethereum is the best example of that. Ethereum ran one of the more successful ICOs of just, you can turn in your Bitcoin for some Ethereum.

23:35And as a result, you had very early investors and users who were aligned properly, right? One of the things that drew me to crypto was that, in my opinion, crypto is the greatest capital formation and customer bootstrapping mechanism that we've ever seen, because it fully aligns your shareholders or your token holders with your customers, right? If you're an early power user of a network or of a project, and you also get compensated for being early and for helping to bootstrap the growth, then you become a power user for life. You become an evangelist for life. You become exactly that sticky user that a project is looking for, right?

24:11The antithesis to that is something like, imagine if you were the first ever Amazon Prime member and you were crucial to getting Amazon Prime off the ground, but you still pay the exact same amount in annual Amazon Prime fees as everyone else. You didn't get any Amazon shares. You got no benefit from being somebody who pushed that together. Or you can go any further. You can go to Reddit and look at that. You can go to McDonald's and look at the misalignment between the customers of McDonald's versus the shareholders, right? Like I saw a Venn diagram once where it was basically like 99.9 % of shareholders of McDonald's don't actually shop there, right?

24:45So we've always had these misalignment and crypto, in my opinion, was bringing that back. And the ICOs were a big part of that. You look at some of the early success stories and there's no doubt in my mind that a lot of their success is because that early users were getting compensated for being early, were being encouraged to be power users, and were being encouraged to be evangelists. You fast forward to where we are now. And of course, everyone's terrified of selling tokens, especially in the US and certainly to retail, that we've come to this backwards way of, hey, we're only going to sell tokens in private rounds to venture funds.

25:20And then eventually we might airdrop the token to you and list it on an exchange. And well, I don't think that was bad in spirit. But what's happening now is you're kind of turning into the equity markets where nobody's in a rush to IPO anymore. You can stay private as long as you can. The same thing is sort of happening in the digital asset world now, where it's like, let's just keep marking up these private rounds because these venture funds have unlimited money and they just want to continue to buy and support the project until they actually list the token, which gets listed artificially high and goes straight down.

25:51And then all of a sudden the support is gone. And if you look at the new issues that have been listed on Coinbase or on Binance specifically, they're all going straight down. And to clarify what I mean by this is there's a couple of different participants in a new issue process, right? First is the founders or the project owners who come up with the token and when the tokenomics and the schedule of who's going to get what and vesting schedules and all that. You obviously have some consultants in there who, in my opinion, are giving terrible advice, but consultants who are helping these projects design the tokens.