Prof G Markets: Paying for Crypto’s Sins — with Mike Novogratz

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1:27Welcome to a special episode of Prof G Markets. Today, we're speaking with Mike Novogratz, the founder and CEO of Galaxy Investment Partners, on the state of play in the cryptocurrency market and what's in store. I like Mike. I've known him for a few years now. He strikes me as a high integrity guy, served his country, seems to be one of the people that's going to emerge from this fire with dragons under his arm. Anyways, with that, enjoy our conversation with Mike Novogratz. Mike, where does this podcast find you? In New York City, having flown home on the red eye from LA. Nice. So let's bust right into it.

2:01You're a longtime Bitcoin bull, and Bitcoin was up 73 % in the first quarter of 2023. That's versus the NASDAQ, up 17%, gold 9%. I think the S &P was up 7%. Walk us through what you think the underlying dynamics were around this pretty serious recovery. Well, I think, you know, we started in the hole. We started in the hole for good reasons, right? Sam Backman, Freed, and FTX really dented people's trust in the whole crypto ecosystem. The Fed raising rates as aggressive as they did. You know, Bitcoin was supposed to come down last year, right? If it's a report card on financial stewardship, Chairman Powell looked like a really serious central banker.

2:43And so he put those two things together, probably overshot. And by the end of the year, there was such paranoia and fear around the whole crypto ecosystem, and Bitcoin included, that anyone who needed to sold probably already sold. And there was a lot of leverage shorts. And so, you know, when markets can't go down, they go up. And a combination of the Chinese. There was a big protest when Xi kind of doubled down on COVID zero and people had that white envelope protest or maybe it was the manila envelope protest. Xi pivoted away from COVID zero real quickly, but he also backed away from Chinese tech.

3:24And so the Chinese crypto people felt a lot more comfortable. So all of a sudden you started seeing Asian crypto and retail coming back in. it didn't take a lot to start moving prices because people were so bearish. And then we got the real acceleration when, you know, you woke up in first Silvergate, then, you know, Silicon Valley Bank. You know, it's really the Silicon Valley Bank Thursday, Friday weekend, where people were like, oh my goodness, here we go again. So the whole reason for crypto or for Bitcoin specifically, which was this hard asset hedge against the debasement of fiat, kind of regalvanized.

4:08People are like, oh, governments, even if they're trying to get out of this debt trap, right, we had this debt orgy, are going to have a really hard time doing it without printing their way out. And I'd say the last thing, which is counterintuitive but real, is that Bitcoin started as a movement where people didn't trust the center, didn't trust governments. And so when you have what feels like an unfair application of the rules, Signature Bank being closed down and Republic not being closed down because Signature was allegedly a crypto bank, that gets people angry. And so that anger incites the Bitcoin community.

4:46And so this is really, in lots of ways, the crypto community coming roaring back. Let's talk about the fiat currency. And I should put my bias up front. I'm on the board of a crypto hardware storage company called Ledger because I wanted to learn about the space, but I'm a no-coiner. And the thing, one of the phenomena that struck me about the SVB run was that there appears to be, and tell me if you agree with this, but a group of people who have such huge investments, including entire venture capital funds and Web3 and Bitcoin, that they have a vested interest in the decline of the dollar. and the decline of the U.S.

5:24banking system. And I look at someone like Mike Novogratz, you've served your country. And the people who are most loyal to the U.S. are its veterans. Do you worry that we have a group of people who are very deep-pocketed, have very large influential platforms, and go on Twitter and catastrophize around hyperinflation or bank runs because they have large investments and assets that go up when the U.S. banking system shows that it might fail? In other words, is one of the most exciting asset classes a bet against America? And is there a problem with that? Yeah, you know, it's a great question. I have probably been quoted 15 times saying, I go to bed every night saying, you know, two All Fathers and one Hail Mary as an ex-Catholic, that the stewardship of the U.S.

6:13economy stays strong. Like, you know, I don't want Bitcoin to go to a million anytime soon. I think Bitcoin in particular is a report card about the stewardship of our government. And I think what Satoshi saw originally was populism, right? That you get to a point where you've got populist governments that just can't help themselves by spending more than they can tax and that they can bring in. And we might be at the point of a really difficult place to return from without at least having some inflating away the debt. And so I always thought Bitcoin was a very good hedge to that portfolio. But as a guy who served the country, the last thing I want is, listen, Bitcoin going a million, we've got instability, we lose civil society, and we're all screwed.

6:58And so, yeah, I, you know, when guys like Bellagio say, I'll bet you Bitcoin's at a million, you know, for effect, it drives me crazy because I think it also really infuriates the people at treasury janet yellen while the dollar is under attack elsewhere it doesn't help and you know when you want the regulators on your side not in your face you know but i do i do get your point and and i've been very careful myself to not be dramatic yeah it's interesting because i mean you mentioned anger that there's a lot of anger among the crypto community and they kind of came back with a vengeance and pushed these assets higher and i think of when i think of anger i think there's got to be a lot of retail investors that came in in the last year because a lot of very smart people with very big platforms were talking about this was going to solve a lot of problems.

7:50And there was the mother of all FOMO. And I mean, a lot of these things, and you're involved in a couple of them or were involved, they didn't go down 30%. They went down a hundred percent. And that the anger out there is a lot of people that feel like they were just, they were fooled by people much smarter than them. What are your thoughts? Yeah, listen, whenever you have a new asset class, there are shysters involved, there are experiments involved, there are fraudsters involved. And I think 2022 was a year where it was shocking how much of that happened. It seemed like over half the industry.

8:26I'd get a call from a friend who was like, is there anyone legitimate to deal with? I do think most of that is being washed away. And there were plenty of tokens, right? We were involved with the Luna ecosystem, which went to zero. Now the guy is under indictment. We'll see what comes of that. That was on its face, a blockchain that looked really promising, that was getting a lot of usage because they had an algorithmic stable coin on top of it that drew people in because they were giving huge returns, 18 % returns, you know, and it was an experiment that failed. It was, I think, a wake-up call to people on how fast some of the new token ecosystems can unravel.

9:15I'm just curious to get your, I mean, I kind of want to say SBF question mark, your turn. Like, what happened there? Did you see this coming? Like, what can be learned from this? What do you think happens to him? Yeah, I think he spends a lot of time in jail. Yeah. And I think it's deserve it. You know, in lots of ways, he snookered the world with, you know, the good education, the parents that were well-educated, working at Jane Street. Jane Street's one of the world's best quantitative trading shops. And so that's like coming from Goldman Sachs. You get that credentialization real fast. He was making money in arbitrage.

9:54There were lots of people doing it. So that made intuitive sense to people. And he started this thing at the right time and then got, you know, Sequoia and Paradigm to give him their impromptu tour. And then no one did any homework. We didn't invest. I remember Sam in our offices. We looked at that round that ended up being a$9 billion round, but we thought it should have been a$1 billion round. And so didn't invest. But we were users of his exchange. And I tell you, I was always frustrated that he was able to have a proprietary trading shop and an exchange side by side and certainly had the suspicion that there was some Swiss cheese walls in between in terms of information flow.

10:40It never would have dawned on me that he was stealing my money. And so I thought he was front-running me, and that was the cost to pay sometimes because that's where lots of the liquidity was in the derivative market. I couldn't prove it, but it was an intuition. But I never really thought he'd be stealing the money. And I guess the one thing that I kicked myself in the rear for is after the Luna thing went down and Sam started bailing everyone out, I kept asking the question, where's he getting all this money? I knew he had spent a billion on mining. I knew he had spent three or four billion or whatever the number was buying his stake back from CZ.

11:22And instead of actually digging in, maybe there's a great lesson in life. I've had these, males probably do this more than females. I answered the question in my own head. Instead of actually digging and getting the real answer, I was like, oh, he must have owned more Solana than I thought and sold it at the high. He must have made money yield farming. And I just didn't dig in deep enough to have, here's all this spending and where was the revenue coming from? And so, you know, we lost, you know, and this is public$75 million on his exchange, just because it was money in our accounts, and we traded pretty actively.

12:01And so that was not a pleasant day. Doesn't it feel like, and I want to be clear, I didn't see it. I remember at one point actually thinking, he's so involved in everything, and the entire asset class seems to be imploding, and yet he's doing fine. It just seemed almost impossible that he would have his fingers in everything. And while this asset class is going from$3 trillion to$1 trillion, he would still be fine. It didn't make any sense to me. But I mean, if you think about, obviously, hindsight, the red flags, no board of directors, no audited financials, incorporating in the Bahamas, you know, a trading platform and a private equity firm.

12:38I mean, it just feels like there were red flags the size of Kansas everywhere. There were thousands of them. And he really, you know you don't meet many sociopaths in your life i was with him three weeks before at the robin hood yeah gala you know uh gathering and he was on stage with larry fink and i was talking to him and larry before they went on stage and you know there was not a beat of sweat on his head it's crazy isn't it like that's what sociopaths there's zero empathy and i think with hindsight the whole you know give all your money away was just a ruse yeah it was a distraction. So I just, I don't know you well, but I know you.

13:18If you end up being one of these sociopaths, I'm going to be blown away. You strike me as a pretty empathetic guy. I've seen you out. I know you have wonderful siblings and value family. How has this been on you, like emotionally and mentally? I can't imagine you weren't on the wrong end of some of this anger with what happened to Tara and Luna. And I mean, this is, you are right in, you know, You're in the combat zone here. How has this been for you? In some ways, you know, I became the unofficial spokesman early on for the institutional part of this business. At one point, we had some, you know, analysis that I was 50 percent of all the media, you know, of the whole space.

14:01And so it was a life changing thing. And then I would walk around Miami and everyone stops and asks for a selfie. That was weird because even as a hedge fund manager, no one knows who you are. But it comes with some responsibility of trying to, you know, be a sober, measured voice. Luna was a painful one in that you learn lessons about how immature the market is, right? We bought Luna at 23 cents or something. What did it peak at? $130. Up about 650x? Right. All within 18 months. Like, I've never seen an investment like that. And so the way I have risk managed my whole life is something goes up, you sell a little bit, it goes up more, you sell a little bit, it goes up more, which is very non-venture, right?

14:50The venture guys never want to sell anything. And so for me, it's a very different investment at 50 than it was at 10. When Luna collapsed, we certainly lost some money on Luna in 2022. but as a whole, it was a very profitable trade. And the sting of others losing lots was real. My Twitter went from being well-liked to less well-liked. And I'm a little more cautious because of the experience. I would tell you that, again, I did the work on Bitcoin and Ethereum. They literally have been the best risk-adjusted investment almost over any time period. You can pick one when they're on their lows, when they go to their lows.

15:37And so like over one year, they don't look as great, but three months, six months, two years, four years, three years, they've been great investments. And so in some ways you feel good about getting people in. What I've learned is it's easy to get people in. It's hard to get them out. Like even friends, when I said, guys, you got to sell your stuff. No one ever pays attention. We'll be right back.

16:00Thank you.

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18:30A few weeks ago, the CFTC sued crypto exchange Binance for illegally operating in the U.S. And within 24 hours of that news, Binance saw almost$2 billion withdrawals. Do you think Binance is in danger of a liquidity crisis? You know, I don't. Listen, we don't know what else is coming from Department of Justice or any of the other regulators in the U.S. My broad framework is that lots of crypto companies, when they started, the ethos was screw the government. And so there was very, very lax KYC in a lot of these companies. KYC, know your customer. And as they realized they had these very profitable businesses and they needed to operate in the real world, they quickly tried to pivot to a much cleaner operating environment and that either regulators are going to go after them for sins of the past or they're going to end up paying big fines and saying, OK, that was then, but now we operate compliantly.

19:39And I think that's what's at stake here with Binance. Crypto is mostly offshore and Binance, the lion's share of their assets are offshore. And there's kind of an anti-U.S. regulator feel in the offshore crypto community, right? So if you go to Abu Dhabi or Dubai, where Binance is headquartered, CZ walks around like a rock star. He's got a French passport. They've set up regulatory compliance in France. And so I kind of think most of the money that was going to come out would have come out after FTX, right? A lot of people thought that Binance was next. I actually flew over to Abu Dhabi like two days later and interviewed him because I wanted to meet him actually and understand like I had money at state, you know, look him in the eye and make sure there wasn't another sociopath.

20:30And again, my sociopath meter isn't perfect, but, you know, he felt like a pretty, he was a Canadian, pretty straightforward, answered all my questions. Again, I have no idea how he'll fare in these suits. But if you look, it's mostly stuff done pre-2020. And I'm guessing it's just kind of Occam's razor. When you're making that much money, why would you take any stupid risks unless you really are deranged? And I don't think he is. And so my guess is he's trying to pay for the sins of the past and negotiate himself. You know, that exchange is 75 % of the liquidity of the market right now. It's a dominant player.

21:07Yeah, I was thinking, again, hindsight. but we look at Sam Bankman-Fried and we look at FTX and Do Kwan at Terra Luna, who my understanding has just been arrested. What can be learned about spotting this stuff? It feels like, all right, shouldn't we be smarter the next time? Is it that whenever you have an asset class, it's kind of mostly unregulated and has this sort of mania, you're going to have bad actors? Well, again, some of this is risk management in an environment when rates went to zero and no one understood what value was. I mean, you don't go to jail for poor risk management. I mean, Greg Becker lost a lot.

21:42I don't think he's going to jail. Right. Some of it is there were a lot of young guys that got into an unregulated industry. And it's interesting. There are very few Wall Streeters. I think of like, you know, Chad Pasquale at Paxos that haven't run tight shops. Now, he's gotten a Wells notice from the SEC. My guess is I'd bet on Chad in that case because I just know the guy. He's just a very straight, you know, ran his business the way you'd want to run a business. Again, I'm not behind the curtain in any of these places, but it feels like there's a regulatory onslaught. The crypto community has been saying for years, geez, we wish you would tell us what the rules are.

22:25And the SEC has been saying, just come to us and register, which is an impossibility because there's no qualified custodians. And so it's this circular game. And so the crypto community broadly said, OK, we don't think these are securities. And, you know, it's been five years, six years, seven years since some of these tokens have been going. And the SEC has been watching them trade. And so it feels quite disingenuous for them to come down and say, oh, by the way, you should have known six, seven years ago. We could have told you what we decided not to tell you six, seven years ago, five years ago, four years ago, three years ago, two years ago, one years ago.

23:04Right. Like, the SEC is in a really weird place here because, again, this is not something that showed up three months ago, right? And so, again, I think one of the crypto hopes in the U.S. is that the judiciary is less political than the SEC and the Biden administration and, you know, will be more fair in how they determine right and wrong. Yeah, it feels as if, I mean, again, from someone who's sort of straddling the line, mostly as an outsider, that the SEC and regulation, I feel like it's a day late and a dollar short. And what you're saying is they might be overcorrecting. Is that accurate?

23:51I think the amount of egg that the Biden administration, and listen, I'm a lifelong Democrat, a supporter of democratic politics, of progressive politics, quite frankly. So I'm in this awkward place that, you know, my team is behaving in a way that I don't feel is rational or fair. Sam was the biggest donor in the midterms to tons of Democrats. Sam was the favorite child at both the CFTC and the SEC. I haven't had one meeting with Gary Gensler at the SEC. And Gary is an ex-partner of mine from Goldman Sachs and a guy that I'm friendly with and that I spoke to right before he took the job and taught one of his classes when he taught at MIT.

24:37Right. So Sam had this privy position and then he turns out to be the biggest fraud. And I think they just have so much egg on their face that they're overcorrecting. You put it together, it's a really bad environment for crypto. I think it's a terrible decision from their perspective. A, there are 50 million Americans that care a lot about crypto. Some religiously care about it. Some just like it. They're voters. And so pre-SAM, there was a bipartisan movement happening. I was in D.C. and we hosted the Blockchain Alliance or Caucus. And, you know, from Cory Booker to Senator Gildebrand to you name them, there were plenty of people.

25:21Senator Hagerty, that were very pro-crypto, that were working on bills to get some rules around this thing. And post-SAM, it just became toxic for Democrats. So a thesis. You're a tier one VC with a huge global footprint in terms of brand. And you invest in projects. And the combination of your brand equity and your capital and your ability to capture the media's attention creates a lot of heat and attention around this project. They launch a coin. They launch a token. It runs up in value because there's very smart people involved in it. And they immediately drop the bag and they don't have to disclose that they're selling because there's a lack of regulation here, including no requirements that insiders disclose sales, wash, rinse, and repeat, making billions of dollars, but leaving just a trail of wreckage.

26:13I think that's happening among the most famous VCs using their brand equity and their capital for the ultimate levered pump and dump. Am I being paranoid? I think it's probably happening a lot less than you think it is. I have said this nonstop that we need disclosure. So much of what happened, even in the retail side here in the US with places like Voyager and BlockFi and Celsius, where people lost a lot of money, they were investing in lending protocols where they thought they were, it felt like you were making a deposit in a bank. Now, if you'd read all the fine print, you realized you were lending to an unsecured company.

26:57It was broadly a poorly managed hedge fund you were lending to. I was public about it. I spoke to, quite frankly, I spoke to the SEC chair before he took the job and said, this is important. Like, this is where people are going to get burned. And people got burned there. And it was all about disclosure. The industry has done a shit job voluntarily disclosing things that should get disclosed. And it's funny because the industry does well by doing good, right? So like if you've got decent participants in the Bitcoin community, you don't have these frauds and the price goes up. If you have malicious actors, the price goes down.

27:31And so you should self-police, but it certainly didn't happen. Okay, so you're clearly a spokesperson or someone who's, you know, quite frankly, one of the last men standing, for lack of a better term. If you see or you feel some obligation for both the community and out of just self-preservation to rejuvenate the brand of crypto or Web3, it feels like the brand has really taken multiple hits from multiple directions. You got criminality. You got a lot of people on Main Street who have lost a lot of money. You got, quite frankly, the technology, I would argue, that most people would think it hasn't lived up to the hype.