Portfolio Construction: Beyond BTC & ETH (w/Jeff Dorman, Joey Krug, Ari Paul, and Raoul Pal)

Portfolio Construction: Beyond BTC & ETH (w/Jeff Dorman, Joey Krug, Ari Paul, and Raoul Pal)

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ASH BENNINGTON: If you love our crypto content  or are looking to learn even more about crypto,   be sure to checkout and subscribe to our new  youtube channel after this video dedicated to   all things crypto. Find new videos every week.  Be sure to check the link in the description. RAOUL PAL: As you know, I don't  think it's all about Bitcoin. I think   this whole digital asset space, whether it's  Ethereum, Polkadot, Cardano, non-fungible tokens,   all of these things that are developing are moving  so fast that almost none of us can keep on top   of it. Even the true experts in the field was  struggling with the sheer amount of innovations,   network effects on top of network effects, and  nascent projects on top of nascent projects,   all builds into something. We've seen the  explosive rise of defi, and this astonishing   new rise in NFTs, digital artwork and IP. There's so many things that really I want  

to get to the bottom of it all, to ask  some of the best investors in this space,   the people I truly trust, to say, hey,  how are you thinking about all of this,   and how can we all benefit from this? How can we  really understand the future of the alternative   investments that laid outside of Bitcoin, or even  Ethereum? Things that we may not yet understand   that we need to get up to speed on. I want to ask  them how they construct their portfolios as well.  That's going to help all of us to figure out  what to do because it is risky out there, because   some projects will work, and some projects  will fail. It's my fundamental belief that   we're at the start of a journey of something  so enormous that we can't get our heads around   what is coming. We are moving into a digital  metaverse where everything is digitized,  

all value is digitized and many of the assets that  we own an exchange of digitized. We can't yet get   our heads around the world that's so different to  the world we live in, a world where we become the   owners of those protocols, where we can invest  actually in that new system as opposed to being   a bystander and letting a corporation or a  government controller to make all the money.  These things are literally revolutionary. I  think there are many narratives within the   market and yet Bitcoin- - there can only be one  and everything else is a shit coin narrative, I   think is so far behind the truth, the innovation,  the network effects that are going. Anyway, I got   my three favorite people together. We've got Jeff  Dorman, Joey Krug, and Ari Paul to take us through  

all of it. Let's first hear from Jeff. Jeff  is fantastic to frame this whole thing for us.  Jeff, it's been a while you've been  on the platform, and I've not spoken   to you on the platform for a long time  now. Welcome back, good to chat to you.  JEFF DORMAN: I'm excited to do this. RAOUL PAL: Listen, I'm a huge fan of  

what you guys have been doing. I blurt all about  Arca to everybody, because I think it's really   interesting. This whole piece, I'm trying to get  deeper understanding and let the audience come   on the same journey of knowledge about the alt  space. Come the world outside of Bitcoin that   people are less familiar with but is massively  exciting. First, I want to get an idea of how   you're thinking about this at Arca and personally? JEFF DORMAN: Sure, yeah. It's important to note   the reason that we started Arca, and the reason  that we have a team now of almost 20 people   all from traditional finance. We don't have  a single software developer on our team. We  

are all traditional finance people. We  came here not because of Bitcoin and  not because of Ethereum. We came because we saw  all these other areas where blockchain-based   assets and digital assets were taking  off. That's where we saw the real value. 

We love Bitcoin, and we love Ethereum and we have  nothing against that, but it really is these other   assets that we're so excited about. -- RAOUL PAL: Hi, I’m Raoul Pal.   Sorry to interrupt your video - I  know it’s a pain in the ass, but look,   I want to tell you something important  because I can tell that you really want   to learn about what’s going in financial  markets and understand the global economy   in these complicated times. That’s what we  do at Real Vision. So this YouTube channel   is a small fraction of what we actually do.  You should really come over to realvision.com  

and see the 20 or so videos a week that we  produce of this kind of quality of content,   the deep analysis and understanding of the  world around us. So, if you click on the link   below or go to realvision.com, it costs you $1.  I don’t think you can afford to be without it. JEFF DORMAN: That's where we saw the real value. We love Bitcoin, and we love Ethereum and we have   nothing against that, but it really is these  other assets that we're so excited about.  

You'll never even hear me use the word altcoin,  or anybody at Arca to use the word altcoin.   The reason is it's not because we're dismissive of  that term, it's that this asset class has evolved   so fast that a lot of the terminology we use  from five years ago or three years ago even is   just immediately obsolete when you start to see  these other assets grow. Altcoins made sense when   it really was an industry of just Bitcoin plus a  bunch of other stuff that nobody knew what it was.  Now, the term altcoin doesn't even really  make sense anymore, because it's really   different sectors in different pockets of digital  assets that do different things. It's almost more  

like the fixed income market. You wouldn't say  that there's Treasurys and then there's alt fixed   income. There's Treasurys, there is munis, there's  corporates, there's high yield, distressed,   investment grade product, structured product, etc.  It's the same thing now. This has evolved into so   much more that you almost have to put that fixed  income hat on when you think about this space. 

The first thing that we do when we educate  investors or when we speak about what we're doing   is we say, let's get rid of everything  you want to do. It's almost like if   you come in with a bad golf swing,  instead of trying to fix your swing,   let's just turn you around to the other side  and start over. We think cryptocurrency is   one of four types of digital assets. Bitcoin  obviously is the biggest cryptocurrency.   You could even argue it's the only cryptocurrency  of any real relevance, but it is a cryptocurrency. 

It is a macro investment vehicle. It is meant to  be a store of value, potentially one day, a medium   of exchange, but there's no underlying asset value  here. It's very difficult to model any cash flows   or anything regarding it. It is a purely currency.  The second type of digital asset is where Ethereum   falls into, and that is your protocols and  platforms. Ethereum is clearly the market leader,   clearly the biggest. Almost everything built in  this space to date has been built on Ethereum, but   there's hundreds of other protocols and platforms. These are other chains that are trying to do  

exactly what Ethereum did. Sometimes I think  about it almost like the iOS App Store. If   you have the iOS App Store, then you have 1000s  of different apps that are built on top of it.   The same thing is happening, only there's  hundreds of different app stores, all of these   different block chains are being built and  ultimately, developers and other projects   will be built on top of these blockchains.  That's a totally different category, totally   different risk reward than anything related to  Bitcoin or monetary policy or macroeconomics. 

The third type of digital assets is what we call  asset-backed tokens. This is exactly what it   sounds like. These are tokens that are backed  by something real. They're backed by equity.   They're backed by debt, maybe it's backed by  an income stream. Maybe it's backed by other   digital assets, but it is something tangible.  You can model this in the same way that you model   a debt or equity instrument using free cash flow,  using dividend yield models, things like that.  There's some really creative examples of this,  most people are probably familiar, or at least   heard about Spencer Dinwiddie, the NBA player who  tokenized his NBA salary. That's an asset-backed  

token. That's a token that is explicitly and  legally backed by the income that he's earning   with his contract with the NBA. You're going  to see a lot more asset-backed tokens. Again,   this has nothing to do with Ethereum, nothing  to do with Bitcoin, they're totally different. 

Then the fourth type of digital asset,  which is probably the most evolutionary,   if not revolutionary, is what we call pass-through  tokens. These are tokens that are accruing real   economic value, and they are passing through  this value directly to token holders. Usually,   it's in the form of like a hybrid security  where maybe it's quasi equity, quasi loyalty   points. Binance coin, which I think BNB just got  added to the top three for the first time ever,   that's the best example of the pass-through  token, so Binance is a real company with real   equity with a real CEO, probably a real Board  of Directors, even though it's an Asian company,   and they introduced the BNB token where if  you own it, you get utility and rewards.  You get to use it to get discounts trading  on their platform, you get to use it to   get access to deals that they bring on their  platform. In that regard, it's more like a  

loyalty reward card, but also Binance takes  a percentage of their profits every quarter,   and they actually go out and buy back and burn  existing tokens. In that way, it's almost like   an amortizing token or like a sinking fund. You  can see how this works all of a sudden. You have   the economic value created from the buybacks  and burns or from the profit pass through, and   you have the rewards and discounts you're getting  as a member or a customer of Binance, and you're   basically putting that together into one security. These pass-through tokens is what's driving defi.   It's what's driving sports and gaming.  It's what's driving NFTs in some way.  

There is a lot of other things happening in  this space, and when you think about those   four categories that I just mentioned, you can  see why I draw the parallel to fixed income.   You have these different pockets of digital  assets that are only related in structure.   They're all digital assets, just like all fixed  income vehicles are all bonds, but ultimately,   they're totally different in their sectors and in  their makeup and in their structure. That's why  

this asset class is becoming so incredibly  interesting from an investment standpoint.  RAOUL PAL: When you're building a portfolio, are  you building separate portfolios for each one of   these asset classes, or are you diversifying  across them and doing a sector weighting?   How are you thinking of this when you put it  all together because they're very different?   Very different, yes, they all have a correlation  to the market overall in some respects, but   not necessarily and it's very complex. JEFF DORMAN: It is very complex. Arca is   an asset management firm dedicated to digital  assets. We are creating products, vehicles,   and strategies that we think have investor  demand. The first part of your question has   to be answered by, do the investors even know  this other world exists yet and is there demand   for that? The reality is right now, there's  not. Most people coming into this space either  

don't even know this other world exists yet or  they have an on/off switch in their head saying,   I'm either going to be involved in digital assets  or I'm not. If I am, just give me the exposure.  I think in two or three years, you're going to see  a lot more specialization, the investors are going   to get more sophisticated. They're going to get  more focused on, well, I don't want everything.   I just want my Bitcoin exposure, or I just want  my platform exposure. I just want asset-backed  

exposure, maybe I want a yield strategy. That's  going to start happening over time, and you're   going to have asset managers like ourselves and  others who are going to start feeding that, but   right now, it's a little more all-encompassing. We built a team of people from the M&A world,   people from venture world, people from traditional  debt and equity world, and we are looking at   anywhere that we can find value in the space.  Sometimes that's in Bitcoin, sometimes that's   in a pass-through, sometimes that's in a yield  vehicle or an asset-backed token. I think,   ultimately, it's growing so fast that you have to  be a little nimble and evolve as this asset class   evolves for now. Then later, you'll see a lot  more specialization where again, you'll have your   separate Treasury funds, your separate corporate  funds, your separate distress funds. You'll see  

that happen in digital assets pretty soon as well. RAOUL PAL: How do you manage the risks in this,   because this is a very volatile asset  class, which is skewed upside so great,   but we also know it's got pretty harsh  downside. How do you think about risk   management within the portfolio of particularly  these less liquid investments that you've got?  JEFF DORMAN: That's a great question. It's  a huge part of what we're doing at Arca.   The very first thing we did when we started this  company was we outsourced to a risk analytics   firm. We said, we need to figure out how to model  this stuff. How do we look at the correlations,  

the betas, the VARs, the inner correlation  between assets? This may sound crazy to a   lot of people coming into this space, but we're  downside investors, we're not upside investors.  That's because I spent two decades in the  distressed world where all we think about   is the downside and not the upside,  but that's how we model this stuff.   We're looking for assets where there is clear  tangible value, where there's clear downside   protection. We're trying to build a portfolio  from a construction standpoint. These assets are   completely non-correlated to each other, as well  as being non-correlated to other asset classes. 

For instance, when we first started this fund  three years ago, almost everything was very highly   correlated to Bitcoin for a lot of different  reasons. One is a lot of these tokens I just   mentioned didn't even exist yet. A lot of these  have come in the last few years. Two is the entire   infrastructure was built around Bitcoin, you had  to trade through Bitcoin to get to these other   assets. As a result, they traded together. Our fund's correlation to Bitcoin   has gone down pretty much every single day  since we started our fund. Our correlation,   actually, to the Russell 2000 and to the NASDAQ  has actually gone up because these are largely   early stage technology companies. Bitcoin, again,  has graduated, it's just being this macro asset   that is being touched by every part of the world.  You have insurance companies, you have macro fund,  

you have individuals and emerging economies,  you have corporate Treasurys. There's no other   asset in the world other than US Treasurys  that are being touched by this many people.  Bitcoin is now a completely different asset than  anything else that we are investing in in our   portfolio. Bitcoin's correlation to gold into  the dollar has gone up while its correlation   to other assets in the digital asset space has  gone down. We can monitor all this stuff from a   risk standpoint, and we can say, okay, at the  portfolio level, how are these assets going   to relate to each other? Then at the individual  token level, we can say, is there asset coverage?   Is there a DCF model that tells us what  this should be worth? Is there a yield   that we're generating on some of these assets? We have real models and real techniques for how   we value these assets. In some ways, it's actually  easier than in the fixed income and equity world  

because we have all these public data available  to us to see how these companies and projects and   tokens are performing. I'll give you an example  of that. There's a company called Nexus Mutual.   Nexus Mutual is part of decentralized  finance, it's defi. They are writing   insurance coverage on all the things that  are happening in the decentralized world.  If you decide you want to use Uniswap to trade  but you're afraid of maybe the risks of hacking   of Uniswap, you can go take out insurance on  Uniswap getting hacked to protect your assets.   Well, Nexus Mutual, the way it works is it's an  insurance mutual, it's very similar to any other   insurance company that you may or may not have  ever invested in. You have to invest capital  

into the pool, and you get back the NXM token.  That token is explicitly and fully backed by the   capital that's in the pool plus, obviously, as an  insurance company, they're going to make money as   their premiums are being paid and as they earn  a float on that capital that's sitting there.  Well, if you looked at anything from like  Lemonade to Route Financial in the public markets,   these growth insurance companies are trading at 50  times book value. Nexus Mutual trades at 1.3 times   book value and actually earlier this year, it was  trading at a discount to book value. That's insane   for any growth asset with real hard assets behind  it. These are the kinds of things that we can   do where you mentioned risk management. I know exactly what my downside is here,  

it's the book value of that company. It  doesn't mean it can't trade below that value,   but I know what it's worth. That's from a  risk management standpoint, we can do it at   the portfolio level and at the individual token  level and run this no different than investors   are used to in the debt and equity world. RAOUL PAL: Fascinating. Let's go through the top  

because there's a lot for people to absorb in this  space, so what I want to do is just point people   in some directions of things that are interesting.  What are the top three most interesting   projects, tokens, whatever that you think  are out there, that are available to people,   because some of this stuff is still pre-trading,  and blah, blah, blah. What are the three things   you said, since you're new to the space,  here's three great projects to look at?  JEFF DORMAN: I use this one a lot as an example  because I think it's both really interesting   conceptually and also a great use case for  blockchain. There is a company called Socios,  

which is a European company, and they have a token  called Chiliz, CHZ. This is in the theme that we   call the digitization of the fan experience. This  is using blockchain to connect sports teams and   athletes and musicians, etc. to their fans. Socios came up with the idea of what's called   a fan token, they are issuing tokens on  behalf of sports teams like FC Barcelona,   Juventus, they actually just came  out with an AC Milan token recently.  These tokens are issued to the fans. If you  own one of these tokens, you become part of the   governance of that team. You get to vote on what  jerseys they're going to wear, who might start  

in an exhibition friendly match, what sponsorship  they're going to take. You're a part of the team.   You actually have a real vote in how your favorite  team transacts, but also, these tokens are traded   on an exchange, so the price of the token actually  goes up and down as there's demand for that team--   not so much like in your game, it's not like  the price is going to go up if a goal is scored   but you actually can see the prices of  these fan tokens going up and down as   the teams make trades for better players, as they  do things that improve the prospects of the team.  More importantly, for our standpoint, from an  investor, we're not investing in the individual   fan tokens, but we invested in CHZ. Chiliz is  the exchange which is basically acting as the  

underwriter and the trading platform for all  of these fan tokens. When you think about the   addressable market of all of these teams that are  out there, they have a partnership not only with   English Premier League and some of the soccer  league, but they have a partnership with UFC,   and they're going to be doing some  things in cricket coming up as well,   you can just see how big the fan base is. All of  these transactions that are happening are going   to accrue value back to the Chiliz exchange, which  eventually accrues value back to the Chiliz token.  It's a really exciting company that  I talked about for a lot of reasons.   One is there's three different investment types  here. You can invest in Socios, the equity,  

if you're a private equity investor, or a venture  capital firm, you can invest in the Chiliz token   if you have a Binance account or if you trade  digital assets, and you can invest in the   individual fan tokens if you're a fan of the team.  Right there, it's really cool in terms of thinking   about a capital structure. There's different  ways that you can invest in this project.  Then from a thematic standpoint, we really believe  that blockchain assets are going to change the way   sports and entertainers directly engage with their  fans. From a thematic standpoint, it's huge for   us. You've seen the rise in eSports, you've seen  the rise in musicians and stuff directly and going   to their fans, this is the next level. Sports  teams, sports channels, they're going to start  

directly engaging with their fans in this way and  it's a perfect use case for blockchain assets.  That's really exciting to us. We love something  like that, and it's probably something that makes   sense to everyone, but it's probably under  the radar that people have never seen before. 

RAOUL PAL: I've been talking about exactly this  for a long time, how big this is going to be.   In an influencer driven world, whether  it's team and a community driven world,   this stuff has huge value. People have not  even started to scratch the surface of this.   I'm interested in this. There's one question  I want to ask. Let's say FC Barcelona issues   their own token, is that a once off sale to  them and they get some money upfront for it,   or do they participate alongside  bear fans in the tokenomics somehow?  JEFF DORMAN: Again, this is what we talk about  in fixed income. There's an infinite number of   combinations of how you can do this things. With a  bond, you could have how many different coupons or 

maturities or call structures, etc. A lot of  these tokens are being structured in the same   way where there's not a one size fits all. In  the case of these fan tokens, I think the early   participants were a little maybe skeptical or  at least wanted to see some proof of concept   before they did it. They basically did it in a  no risk situation to them, they basically said,  

here, go ahead and issue this token on our  behalf. If it works, then we'll participate.  Now, that there's some proof of  concept, and there's some success,   the teams are doing a little bit more hands  on. They're saying we want to be involved   with how many tokens are outstanding, with  the schedule for future release of tokens,   maybe they're going to own some of the tokens  themselves and give them out as rewards to fans   for certain things. There's a lot of iterations  happening right now, but it's definitely working. 

There's a site called CoinGecko, where they  have a section called Fan Sports Tokens. You   can see all the different fan sports tokens  that are out there, and how they're trading   and how they've grown. It's really cool because  this is like a grassroots effort of just fans   that are not only getting to engage with  their favorite team, but now they're being   rewarded economically for it as well. RAOUL PAL: Also, it creates a market   where I can now bet on the future  success of AC Milan vs FC Barcelona,   because you've now created a market which is not  sports betting, but it's betting on the team. Yes,   some of these have equity so you could do it that  way, but this is a democratized version of that.   Again, amazing breakthrough. What else on  the radar screen that people should look at? 

JEFF DORMAN: Another one, we've been big  investors in decentralized finance for a   long time, we were a big believer in that.  To dumb down what decentralized finance is,   it's really just taking all the traditional  finance applications that you're used to,   everything from banking, to insurance, to asset  management, to exchange trading, and you're doing   it in a decentralized way where there's no actual  middleman. We've been big believers in defi for a   long time. Obviously, that's a buzzword now, but  a year ago, most people have never heard of it.  There's a lot of really interesting innovation  happening in defi. One that we like that is a   little off the radar and a little smaller cap  is a company called Hxro. They tried to gamify  

options trading. For anyone who's familiar with  [?] trading options, options can be complex. Not   only do you have to think about the strikes  and the vol, and the time value of money,   but also obviously there's a fair amount of risk  involved when you're doing binary options. Well,   these guys at Hxro, they're their ex-floor traders  from Chicago who had been doing this for 20 years.  They said, why can't we gamify this? Why can't  we make it in a way where it looks more like   gambling? Where it's like, I know exactly what  my odds of a payout are, I can go buy a 60,000   Bitcoin strike, but instead of worrying about my  faders, and my deltas and my gammas, here's just   the payout. It's going to be two and a half to  one if you hit 60,000 by the time February 26th   rolls around. Well, they did it as, again, they  started as a regular company, a real CEO, a real   organization. They are slowly decentralizing this. They have a hero token, HXRO, and there's a  

proposal out there right now to make the HXRO  token own 100% of the revenue that this company   generates. They're decentralizing the ownership of  this company and incentivizing you to go on there   and play and then you get rewarded financially  if you're a customer of this project. It hits   all the themes and buttons for us. It's a strong  management team. It's a growing market, digital  

assets. It's gaming and blockchain, putting it  together. It's decentralization all at once.  It's totally under the radar. It's less than  $100 million market cap compared to some of these   $20 billion, $30 billion market caps, but they're  really hitting on something that has real product   market fit and real demand. The way I think about  it, this is again an example of that pass-through   token. Not only do you get rewards when you own  the HXRO token when you trade on their site,   but you also get the financial benefit  of those revenue pass-throughs.  It reminds me of Amazon versus Amazon Prime, and  I've used this analogy before. If you're an Amazon  

Prime member, you're getting all the benefits  of Amazon. You're getting Whole Foods discounts,   free shipping, movies, music, but you're not  getting any financial benefit. If you're an   Amazon shareholder, you're getting all the  financial benefit, but you don't even have   to be an Amazon user if you don't want to be. What these digital assets are doing is they're  

combining those two. If you're an HXRO token  holder, you're a customer, you're getting benefits   by using their platform for owning the token,  but now you're also getting economically rewarded   to bootstrap that growth and it's brilliant. RAOUL PAL: As a behavioral incentive system,   this is just mind blowing. The change in this,  the merging between user and equity owner   is incredible because it creates  network effects everywhere.  JEFF DORMAN: We think tokens are the greatest  capital formation and customer bootstrapping   mechanism that have ever been invented. We think  it's only a matter of time before every company  

has a digital asset in their balance sheet and  in their capital structure at some point. The   way we think about it, again, using those examples  like think about McDonald's. McDonald's has almost   probably no overlap between their shareholders  and their customer base. That's insane.  We can change that, we can make it to a point  where your customers, the people who are driving   the interest in the company's future are also  the ones who are economically motivated. When   you think about that, what you're doing is you're  turning all of your customers immediately into   evangelists. It's going to bootstrap the  growth of every company you can think of,   from your local gym to your local restaurants,  to your hairstylist, you name it. I think every  

company from the airlines to Starbucks,  etc., they're all going to have a token.  This token, like I said, it's going to be part  of the capital structure. You're still going to   have debt, your debt is going to be a claim  on the assets of the company. You're still   going to have equity, the equity is going to be  a claim on the revenue and growth of potential   the profits. Then you can have a token, which is  a claim on future customer growth or a claim on  

network growth. All three of these are going  to sit in a company's capital structure,   and every company is going to have a token. RAOUL PAL: The only issue is still,   and I've been thinking through this,  is in M&A, the traditional holders know   what happens in a change of ownership structure. JEFF DORMAN: Well, I think it's more of a   liquidation than M&A. We've seen M&A. In  fact, there was a company, Voyager, who just   did a merger with LGO, both of which had public  stock, but Voyager has a token. It just improved,  

the token went up from 10 cents to $5 because all  of a sudden, this was a bigger, stronger company   and those revenue pass-throughs are going to be  bigger. As long as the company in an M&A scenario   is still a going concern, you can tweak the token  to fit whatever that going concern is going to be.  That's the beauty of tokens. It's not locked  into one thing. It's not like stocks or bonds   where you know exactly what you own the day  you buy it. With tokens, you can change the  

tokenomics anytime you want. It's frightening  from that standpoint. You have less protection   from bad actors, but it's also riveting from  the standpoint of "great, I can evolve as the   company evolves", instead of backing a company  and hoping that they pivot into a new market,   they can stay in the market, but pivot the token  to make sure it works within what the company is.  I think in an M&A scenario, there's not  a lot of precedent here. Like you said,   you're going to see bankers emerge, you're  going to see different token structures and   how it reacts. I think the issue with more  is going to be in liquidation scenarios.  

I don't think you're going to have liquidation  preferences if there's bankruptcies or if there's   defaults. I think in pure M&A or just growth  stories, you're going to see these tokens   evolve to fit exactly what the company is  doing. Because like we just talked about,   if this is helping drive customer growth and this  is engaging your users, you're going to find a way   to keep this going and not kill the golden goose. RAOUL PAL: Okay, what's the third one?  JEFF DORMAN: Third interesting company. I'll try  to find one that's maybe a little off the road,   because I think everyone's probably heard of  some of the defi ones at this point. They've   heard of some of the other ones.  All right, I've got one for you.  

Axie Infinity. Axie Infinity is a game. I'm going  to preface this by saying that I'm 41 years old,   I don't play video games anymore. I've got a  team of youngsters here at Arca, who do this.  When anybody who has played a video game, you know  that you're at the mercy of the game. Whatever you   do in that game, the game owns it, you don't own  it outside the game. One of the unique attributes   of blockchain is that you become the owner  of the asset. If you earn an asset in a game,   you in theory can take that asset out of the game  and trade it or do whatever else you want with it.  

You can envision, maybe I need to get a sword one  day to unlock a new level but that sword is also   valuable for other games, I'm going to take that  sword with me and bring it over to another game,   or maybe I'm done playing because I just turned  41, and I'm old, I'm going to go sell that asset   to someone else who's going to use it. Blockchain-based games are on the rise,   and Axie Infinity is a pretty cool game where  you build these characters and you build these   characters to fight battles, you buy land,  you do all these things in a mini ecosystem,   in this Axie Infinity ecosystem. The Axie token  actually backs the treasury of the company and   that treasury gets built every time there's one  of these transactions. Every time one of these  

characters gets traded, or a piece of land  gets traded, or there's transaction value,   there's a revenue. There's a fee attached to  that, and that revenue sits in the treasury,   and the Axie token holders own that treasury. Again, this is a combination of a pass-through   token with an asset-backed token. It's asset  backed in the sense that you own the actual   assets in that treasury, but it's pass-through in  the sense that when you're an Axie token holder,   you get to participate in this game and use  those tokens in the game. It's just one example.  

There's a lot of different games out there, but we  think it's really interesting because it combines   again all those elements that we're looking for. Strong management team, strong product market fit   in blockchain gaming, really unique use case for  how the token integrates into the game as well as   economic value. These are the things that we're  looking for. You mentioned earlier, like, how   are we doing this across an entire asset class? RAOUL PAL: I'm just thinking the same thing as I'm   listening to you. I'm thinking, how the  hell do you keep on top of all of this? 

JEFF DORMAN: This is a 24/7 market, and we  have a team of eight people on our portfolio at   Arca that are working basically 24/7. This is  not the easiest thing in the world for a retail   investor to come in and just do on your own  but inevitably, because of this network growth,   because of the way people are incentivized to  talk about the things they're doing, inevitably,   you're going to hear about one-off assets here  and there and there is a way to go in and do   some research on it on your own and learn about  it. The younger generation of investors is the   smartest we've ever seen in terms of doing their  own work and learning about things. They just need  

to be brought to the attention of what it is. I think the takeaway for me when I'm thinking   about talking to other people is don't  classify everything as an altcoin. Don't   think of everything as a cryptocurrency.  If somebody presents something to you,  

break it down in your head. Okay, what  sector is this? Is this gaming? Is this   defi? Is this Web 3.0? Is it something else? What does the token actually do? Is the token   not attached to anything and we're just going to  figure it out later, or is it actually attached   to something? Is there real cash flows? Is there  a real yield? Is there a real use case for it?  You're not going to be able to cover  the entire space. It's growing. Just   in the 30 minutes we're talking right now,  there's probably three new tokens my team   is evaluating that I've never heard of. You're  not going to be able to cover the whole space,  

but you are going to be able to think about this  space in a more logical way and not just think,   oh, there's Bitcoin and hundreds of other coins. RAOUL PAL: Jeff, that is fantastic. I just   learned so much in half an hour. It's just really  inspiring. The opportunity and the change, a lot   of change. What's going on here is just like you  and I've been in the traditional finance business  

forever and we've just been given entirely  new sandbox and realize it's not a sandbox,   it's the size of the Sahara Desert. It's massive. JEFF DORMAN: Yeah, you can see it in my voice, you   can see in my face. I've never been more excited  in my career than doing what I'm doing here.   Like you just said, we spent decades in  traditional finance, and there's pockets   of traditional finance that are really exciting  and interesting, but this is this whole new oasis   that nobody knows exists. We are the pioneers  in something that the world doesn't even know  

exists yet. You can just see how exciting and  fascinating the growth of this is going to be.  RAOUL PAL: Jeff, brilliant, my friend, good  to speak to you as ever, and we'll catch up   for a longer chat one day soon. JEFF DORMAN: Looking forward   to it. Thanks for having me, Raoul. RAOUL PAL: Jeff, as ever, brings the  

goods. I'm so interested in what they're doing  at Arca. They're approaching a space really   differently. I think now, it's time to get to  some of the most established players in the space,   and the really big established player is Pantera.  They've been in this for a long time. Dan  

Moorehead's a good friend of mine, and I really  admire what he's managed. Joey runs the portfolio   for Dan in this whole space and I think it's going  to be great to hear what he thinks is going on,   because he's going to be slightly different to  Jeff and would be focusing on different things.   Joey, good to see you. JOEY KRUG: Yeah, you too.  RAOUL PAL: I'm trying to get my knowledge base up  faster about the old sword digital asset space,   because I think many people came into this world  in Bitcoin, and maybe a bit of Ethereum. I think   people are starting to realize that there's  actually a much bigger revolution going on. I'd   love to get your thoughts on what really is going  on in this digital asset space, where are the   areas that you see it building out, and how are  you thinking about that in managing portfolios?  JOEY KRUG: There's really two big areas, one,  which is just massive. The first massive area  

that's really exciting right now is decentralized  finance. It's this concept of you take the   existing financial system and you remove most of  the middleman, you open it up, you make it global,   and everything trades 24/7. There's no bank  holidays, you transfer the money in 30 seconds.   I think that's just the direction that finance  is going to go over the next 5 to 10 years,   and there's a huge amount of  assets in the space in that area. 

The second area I think that's interesting, it's  much, much smaller, but is potentially interesting   is the non- fungible token space. This is the idea  of you have digital art, you have artists who are   basically taking the advantages of blockchain  tech, which lets you send something that's   non-counterfeitable, and applying  that to things like snippets of songs,   digital pieces of artwork, that kind of stuff.  That's much earlier than defi, but I think   it's another interesting area in this space. RAOUL PAL: Let's dig in a bit of defi first.  

There's a lot going on. How the hell do  people stay on top of all the things going on?   People don't really know what the risks  are, and that kind of thing. How are   you thinking through the whole space of  defi? How are you asset allocating in?  JOEY KRUG: Yeah, there's a zillion things  going on. That's correct. One thing is you   have to read all the time. There's tons of  different mailing lists where people send out  

updates of what's going on in defi this week,  because you can't pay attention to every project   all the time, so newsletters and mailing list is  a big thing. Then you have the major projects.   As an investor, when you first start looking  into this space, I think about constructing   a portfolio around the major assets. If you look at defi, the major assets   really fall into I'd say two buckets. You  have decentralized exchanges. Think Coinbase,   or Binance, but decentralized, and then you  have lending protocols. Within each of those   categories on the decentralized exchange, or DEX  in short, category, you have Uniswap, SushiSwap,   Eurex. They're the major players. Then in  the lending protocol space, you really have   three big players, MakerDAO, Aave and Compound? RAOUL PAL: How do people think about the risks   in this space? Because obviously, the yields  are pretty high, that's in the lending side,   how do you think about risk on the lending  side? We'll talk about a bit about the   decentralized exchanges as well. Talk about  the risks, how people can think through this? 

JOEY KRUG: I think on the lending side, there's a  couple risks. One is the risks that you have with   using these smart contracts. If you think about a  legal agreement in the traditional world, if your   lawyer makes a mistake, you can generally work  through it. In a smart contract, if the computer   programmer made a mistake, you could potentially  lose all your money. That's a big risk.  One thing that has popped up is there's these  protocols that will let you buy insurance, so   you can loan some money out or borrow some money,  and then you could buy insurance on it. If the   protocol gets hacked, or something bad happens,  you get an insurance payout. There's a lot of  

different people working on that. The other risk  is just if you're borrowing on these protocols,   you have traditional margin call risks that you  would have in any market where you're basically   borrowing on margin. I think  those are the two big risks.  RAOUL PAL: In terms of the   insurance space, what premiums are you  paying? Let's say you're getting a 6% yield   on something and you want to buy insurance on  that particular thing, what kind of cost is it?  JOEY KRUG: Costs can be a lot. Costs for a  protocol could vary anywhere from-- for a really   secure protocol, you might pay a few percent a  year to insure it. If you get something that's  

been around for a very long time like MakerDAO or  Compound, or something that's more speculative,   you have to do like a protocol like Alpha  Homora, which is a leveraged borrowing and   lending protocol. Insurance on that one very  recently cost you about 25% in premiums a year.   That was actually for good reason, because Alpha  Homora actually recently, there was like a hack   incident that happened with it so the insurance  markets were right to make the cost higher.  RAOUL PAL: Talk to me about decentralized  exchanges, because people aren't familiar with   it. It sounds a bit weird, because everybody's  using these exchanges. That's where you go, it's   run by a company, you have recourse, you interact  with a company, and you buy and sell through that.   Talk to people who aren't that familiar  with what the DEX is all about?  JOEY KRUG: One thing that's interesting, too,  we talked about this recently in our investor   letters, if you look at what happened with  GameStop, it actually exposed a lot of reasons   why decentralized exchanges exist. If you think  of traditional exchanges and financial markets,   you have the exchange, you have a broker,  which provides an interface to the exchange,   and then you have a clearinghouse that handles  a bunch of capital and handles the shares and   handles settlement and all that stuff. All of that stuff takes a lot of time,  

the trades take two days to settle. They used to  take three days. Before that, they took five days.   If you look at the crypto space, this concept  of decentralized exchanges, it basically says,   what if we remove the broker, the exchange, and  the clearinghouse, and replace them all with   a pretty simple usually 500- to 1000-line  computer program? Once you use it, it's really   hard to go back like when I trade do something  traditional on E*TRADE, it feels like you're a   dinosaur compared to what you do on these defi  exchanges, because you do the trade, it happens,   the trade goes through, and you have your money  immediately after. That's the huge benefit.  Even if you're comparing within crypto,  decentralized exchanges versus say   a site like Coinbase or Binance, with Coinbase  or Binance, you have to send money to them.   It takes 30 minutes to an hour for them to  confirm that it arrived. You do the trade,  

you're doing it for dollars, you have to withdraw  back to your bank account. It takes a long time,   and so most of trading on decentralized exchanges  is between other cryptocurrencies or between   cryptocurrencies and stablecoins. Most the time  when we're trading these days, we rarely ever   go back to actual US dollars. If we wanted to  sell something for fiat, we'd sell it for USDC  

and not even have to touch the banking rails. RAOUL PAL: And you get yield on the USDC anyway.   Which is amazing, because you're getting a  high yield that you get in the dollar market.  JOEY KRUG: That's right. RAOUL PAL: It's extraordinary.   Let's talk a bit about NFTs as well because that's  really exciting, because it moves out of the world   of finance and now gets into the internet  of value, I guess, and the tokenization of   everything. Talk us through what you're seeing  in that space and how you think it's evolving.  JOEY KRUG: In the NFT space, when I  first saw this space a couple years ago,   I wasn't really sure whether  it was digital Beanie Babies,   or whether it's something actually interesting.  Over the past couple years, it's evolved a lot   and you see a few different players in the  market. You have marketplaces that are like eBay,  

but for all digital goods. There's a website  called OpenSea that lets you basically   buy and sell and trade all these digital goods.  Then you have like these more curated experiences.  Think of an art gallery that you  might go to in the physical world,   but these are for digital items. You have sites  like Foundation or Wearable that you can go to,   and they basically have these curated selections  of various pieces that artists have made. Then   the way it works is it's a really wacky concept  to wrap your head around because you're buying a   digital good. There's no reason you couldn't take  a screenshot of the artwork and download it and   display it on your computer or whatever, but the  big difference is that when you're buying it from   the artist, you have the provenance. If I downloaded a digital item  

and display it on a display on my wall in my  home, I could tell somebody that I did it,   but I don't actually own the artwork that I  bought from the artist, just a different steering.   That's the insight behind this NFT space. RAOUL PAL: We've seen that in photographic art.   If you've got signed a photographic original or  a limited edition signed by the photographer, you   can have the same picture, but they have two very  different values, because of digital scarcity.  

Where else is this space going? Because we're  seeing communities issue tokens, we're seeing   sports stars issue tokens, we're seeing all sorts  of stuff which fall into this NFT style umbrella.   Where do you think this space is going? Because  this feels really exciting, and very broad.  JOEY KRUG: Yeah, it's extremely broad. I think  another area that we'll see a lot that I think   is going to be pretty big is musicians. Maybe  instead of releasing a traditional album,   they'll auction off each individual song to  the highest bidder. Sure, anybody can listen   to the music, but you get to know that you bought  whatever the number one hit is from the artist.  

You probably don't even get that much of  a benefit from it beyond the satisfaction   of knowing that you bought it from them or  the cloud or whatever that comes with that.  It's very similar to traditional art in that  sense, but you already see artists starting to   do this. The band Linkin' Park actually recently  sold like a portion of one of their songs   as an NF T. You're seeing NFTs being auctioned at  auction houses like Christie's recently. I think a   lot of it's in art, whether that's actual artwork,  or whether that's music. I think the other area  

that we'll see a lot of NFT stuff happen  that's maybe a bit further off is video games.  You think about things like a sword  in a game like World of Warcraft,   that has real world value to somebody. You can't  really effectively trade it beyond maybe-- I don't   even remember if the game has an auction house in  the game or not, but if it did, you could trade   it through that. I think someday we'll see these  items actually trade on NFT marketplaces where you   can buy them with real world money. That's not  even that big of a logic jump because already,   game developers make-- I think 80% plus of their  revenue these days is from the sale of in-game   items as opposed to somebody going into the  store and buying the video game in the old days. 

RAOUL PAL: A lot of people who are of the video  game generation don't realize that digital assets   already have value for hundreds of millions of  people. People buy and sell digital assets all   day. When you talk about, well, people need to  get their heads around digital art, that's not   odd in the gaming world. It's normal. Talk me  through what you think the best three or most  

interesting opportunities right now that you're looking at, just to give people a context of   the differences in just some interesting  stuff, because there's a lot for people to   get up to speed on this. Give me your top  three and why they're interesting to you.  JOEY KRUG: I'd say maybe the top category would be  this idea of decentralized exchange aggregators.   These are things like 1inch and Matcha. What  they do is they let you create across 40 or 50   different decentralized exchanges in one click.  They'll route your order everywhere and give you   the best price for any cryptocurrency pair that  you want to trade. That's something that's like,   if you're interested in crypto or you want  to buy and sell them, that's useful. Today,  

actually provides a lot of value, we use it in our  hedge funds, we're creating certain tokens because   it actually offers better pricing than some OTC  desk or traditional exchanges in many cases.  That's one I think that just powerful.  Then the second one is probably it's a   little bit more abstract but this concept of  layer-twos. If you look at blockchains today,   they're pretty slow. Ethereum still only  does about 20 transactions a second,  

it really needs to be in the 1000s for it to  become this new parallel financial system.   There's a lot of projects working on these  layer-twos. There's none that you can buy in   the public markets yet, but I think there will  be over the course of the remainder of this year   projects like Arbitrum or Offchain Labs.  There's a bunch others like Matic is   another one that's out there, Optimism is  another one. Those are worth looking into. 

Then I think the third thing is probably  things like Maker are very interesting.   There's people also trying to compete with Maker  launching competitive projects to it. What Maker   is it's a fascinating concept. It's basically  like a central bank, essentially, but it's   decentralized, it's community governed, and it  issues a currency that's pegged to the US dollar.   In theory, you could issue things  that are pegged to other assets too,   it doesn't have to be dollar-pegged, that's  just the first thing that they launched.  >What's powerful about that is it's the only  stable currency out there that doesn't involve   backing things with collateral in a  bank. It's totally digitally native,  

doesn't require dollars sitting in a bank account,  which as you and I both know, there's a lot of   problems with that. If you're trying to get  away from the old world, you can't just shove   dollars in a bank account and tokenize it and  call it a day. Maker actually has a solution   to that problem. I think that's a great project  to look into, too, if you're new to this space.  RAOUL PAL: The other thing that interests  me is the interoperability layer.   People are trying to connect the tracks, how  are you thinking through that as well? Because   that feels like a big opportunity as well as we  build out a stack and get closer and closer to   integration of everything. JOEY KRUG: Yeah, I totally agree.  

If you think about the internet, it'd be weird  if you had only websites that had a backend in,   I don't know, C++ that can interact with websites  that had a backend in Python or something. That   would be weird. That's how blockchains work today.  Yeah, interoperability is going to be a thing.   There's a lot of projects working on it, I'd say  two of the biggest ones are Polkadot and Cosmos.  I think the way it will work long term is you'll  have what are called bridges between these various   block chains, and it may take five minutes to  switch chains for your money to get over from   one bridge to the other, which sounds like  a long time, but if you think about a bank,   man, the fastest you can get a wire is same day. If you call them between a   certain time window, and then they'll call you  back and say, hey, are you really sure you want   to do this transfer? Are you really sure you want  to send your money out of Wells Fargo? It's like,   yeah, I'm really sure. You just don't have that  here. It's just a way better experience, I think. 

RAOUL PAL: You run a portfolio of a bunch  of digital assets. How do you think about   these volatile tokens within a portfolio,  how do you think about portfolio   construction and asset allocation within this? JOEY KRUG: I think if you look at construction   portfolio, you want to have exposure to all  the main categories. You want to have exposure   to layer-one blockchain, so things like Bitcoin  and Ethereum. Bitcoin and Ethereum are like the   base assets. In our funds, we really underweight  Bitcoin. The reason is, I don't think it makes  

sense to charge somebody 2 and 20 to buy bitcoin.  You can get that really cheap, so go ahead and get   that really cheap. Then I think the other assets,  Ethereum is this smart contract layer. It's gotten   a lot more popular recently than it used to be  a few years ago when people love to hate on it. 

Then you have this huge universe of stuff  outside of those two assets. Outside of that,   I think, defi is the biggest next investable  asset area in this space. In any portfolio,   I want to have exposure to both decentralized  exchanges and lending protocols. Then within that,   what I'm trying to do is I'm trying to buy the  protocols that are seeing the most growth in users   traction, volume, etc. adjusted for valuation.  If something's trading at like a multiple 200x,   it's probably expensive, I might not buy it. If you look at something like SushiSwap when   it was trading at $8, that was already after a run  up from $1 or something, so it's like a 7x run up,   we actually put a position on the dollars. The  reason why is it was trading at-- or applying  

the pool of about five, and it had grown five x  plus in the last couple months. You can't get a   deal like that in any market, early  stage venture, traditional equities,   anywhere. Defi is like super interesting to be  looking at from a capital allocator standpoint.  Then the last area that I look at is some  of the scalability, interoperability layers,   so things like Polkadot or Cosmos. I wouldn't  put a huge position on in those for like a  

broadly constructed portfolio, but  if they start seeing more traction,   you can ensure position sizing up there. Then the  very last piece that I think is interesting to own   is decentralized exchange tokens. I wouldn't  own a huge amount in a portfolio of these,   but things like BNB, MOBI token, that kind of  stuff are an interesting exposure to this space. 

It's not as correlated with the prices of  things. Because even if you'll go back to 2017,   prices went down a lot in 2018, the volumes were  actually up year-over-year from November of 2017   to November of 2018, and so centralized  exchanges, rather, have this exposure that's not   super correlated with the prices. It is, but  it's not as correlated as everything else.  RAOUL PAL: Once Coinbase IPOes, that'd  be a reference valuation as well   out there. I think it will expose the  whole space as being cheap, I guess. 

JOEY KRUG: Yeah. If you look at something like  Uniswap, which on some days does 40% or 50% of the   volume as Coinbase and Coinbase is trading at 100  billion and Uniswap was trading at 20 billion, and  the team of Uniswap is 11 people. It's  like, what else is app disruption more   than that? I don't know. That's an insane  statement even just saying it out loud.  RAOUL PAL: Do you trade around positions,  or do you buy and hold? If so, what time   horizons do you have in this space? JOEY KRUG: I'd say we have a couple   different funds. One is venture in companies,  one is early stage tokens, and in those ones,   you basically just hold the position for  the most part. Our third fund or hedge fund,   that one, we will trade things around. I'd say  the main thing is we have a fairly long term  

time horizon, though, but we will sell a position  if the thesis that we got into it changes.   If we invest in something, and the founder backs  away into these, not interested in anymore,   which sometimes happens in the public  token markets, that's a big sell signal.  There's also just we will change the weights  of things if something gets really overvalued   relative to the other. An example of this is  looking at Bitcoin dominance versus Ethereum.   When Bitcoin dominance gets above 70%, it's  usually a good trade to do the opposite.  

If you look at defi assets, sometimes you can  trade around things like SushiSwap versus Uniswap.   That's a really interesting market where SushiSwap  trades at a very low multiple relative to Uniswap   because people think SushiSwap is like a joke  project that might disappear in six months.  If it's still around in six months, that multiple  is going to go way up, is my personal opinion on   it, just because the market's no longer going  to think that it's going to disappear overnight.  

There's a lot of different things that we look at.  The very last thing about trading is we sometimes   take risk off when we think that the market Basically, one or two things would happen is what   we thought at the time. Either it was going to  run up and do a blow-off top like in March 2013--   I think I tweeted about this too-- or it was going  to go down 25%, 30% and 25%, 30% drawdown is what   happened. Then we got back in and now things are  going up again. That's how we think about it.  RAOUL PAL: It just smooths out the volatility  over time if you get a few of these. You don't   get all of them right, but few of them right.  Listen, Joe, thank you for letting me pick your  

brains on all of this. I think it's really useful  for people. You guys at Pantera are trailblazers   in all of this, and it's always astonishing to  see what you guys are up to. Just well done,   and I look forward to chatting to you again. JOEY KRUG: Thanks for having me on. RAOUL PAL: All   right. Take care. Thanks. ARI PAUL: Take care. is pretty overheated. If you look back in January,   I think it was January 9 30% risk off in our fund   because we thought that, well, a lot of the  indicators that we follow were just screaming.

RAOUL PAL: Ari is another long standing friend of  Real Vision and one of the people that I really   trust in his opinion. Again, he comes in a very  different way. He's much more of a trader than the   others are. That's going to give us a different  unique perspective on how he thinks about this.   I think all three of these added together are  going to give us the full context we need to   understand really, how to take advantage of this. Ari, you're one of the people I really wanted   to pick the mind of about the whole  digital asset space overall, because   it was actually when you and I was speaking  recently, you were talking about building a   basket of other crypto or tokens or whatever for  the more risk-on phase of the bull market. That   got me thinking a lot about this. Obviously,  I've been monitoring a lot of these things,  

but I'm starting to think that this whole  thing is much bigger than most people realize.   People are still very focused on Bitcoin  or Ethereum, and maybe Polkadot and a   couple of others, but it's a very big thing. How are you thinking of the whole digital asset   space?

2021-04-17 08:37

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