Looming Insolvency & Crypto as Reserve Currency (w/ Raoul Pal & Dan Morehead)
RAOUL PAL: Okay, we know this is screwed, my view is this is probably going to be the biggest insolvency event of all history. That's going to take a strain on the financial system and possibly force the dollar up. I don't know what your views on that is, and then where does this go? DAN MOREHEAD: Yeah, I love that US Treasury Secretary Connolly in the '70s said the dollar might be our currency, but it's your problem to Europe. It's a fact of the world that the dollar is the reserve currency right now. That's changed every 80 or hundred years over the last six centuries. It used to be the Portuguese escudo and the Spanish real, and now it's the-- then the pound, and now, the dollar. There really isn't another candidate in the fiat currency world. I do think in the long run, and this is decades, cryptocurrencies will become reserve currencies. Whether it's Bitcoin or Ethereum, Ripple, whatever, ultimately, some of those will be reserved currencies, but government's very slow to change and so I think that's a 10 to 20-year very slow progression, but that would be the answer. I actually thought the original construction of the Libra project that Facebook created was genius is to use a basket of four currencies. You're creating like a virtual SDR. The SDR is a great concept, but you couldn't actually transact in it. Creating a basket of currency where the Libra does it or somebody else does it, somebody will ultimately do it. That could easily become a reserve currency. It would be essentially like-- yeah? RAOUL PAL: I love the fact that the dollar was part of the basket. Therefore, the basket itself should only move up and down with let's say, global money supply. It becomes a true stable coin in our terms of the different world. That's an extraordinarily powerful thing. I think most people didn't understand what Libra was, until it came out. It looked at it was like, oh my God, this is game changing. DAN MOREHEAD: I agree. I thought it was beautifully designed. I thought they did an amazing job designing it and there was so much fuss about the rollout and that all the lightning rod attention to Facebook, the brand, but the product they designed was genius. Hopefully, they'll get theirs out but if they don't, someone will do something very, very similar to it. That's essentially what everyone on earth wants, is a currency that's tied to, if they're European, it's tied to the euro. If they're Japanese, it's tied to the Japanese yen. If they're in the United Kingdom, it's tied to the pound, and US tied to that. It's not too volatile relative to their own currency. If they're in some other country or region, it's not very volatile. I think it's the best of both worlds. It's not pegged to one single currency, but there's not crazy volatility, like Bitcoin or Eth would be. Ultimately, someone is going to do that. Then central banks will start using it. Again, it's going to take decades, but central banks will start using that, it's the only way I see to get away from the dollar hegemony that people are always griping about. RAOUL PAL: I'm a little more bullish on the time horizon because I think this event is bigger than people could understand. If there is an event that breaks the system, or at least forces people to adopt different things, and they would have adopted at this stage, I think this would be it and again hearing Benoît Cœuré of the ECB, and Mark Carney and a bunch of others talking about digital currencies, it feels like they want to move towards this basket idea. Now, whether it's done with Libra without Libra or something, I think they've all spoken about how the dollar standard just doesn't work for them anymore. I'm not so sure that that might be the surprise outcome of this which will massively help all the cryptocurrency world and everything else because then, the world is digital off ramps and digital on ramps. DAN MOREHEAD: Yeah, you're right. I think that one of the important things to do in this distressing time is think about the silver linings and the things that are positive about this massive disruption in-- like you and I working from home remotely might be part of it. The whole world might change how they actually do business. There's a lot of good things that could come up. You're right, really focusing on our monetary system, we might end up with blockchain being accelerated by it. I've seen great examples. We're invested in a company that helps people move money using physical fiat money, bills and coins, converting it into bitcoin and being able to send it to their family wherever they live, either domestically or often in a remittance payment. They're seeing record volumes because the fiat systems are grinding to a halt, where you can still go to the safe way, pump $400 in the machine and have it pop out the other end. I think you're going to see some use cases where blockchain really comes with its own in this crisis. RAOUL PAL: How are you seeing the space evolve and things must be accelerating. I've always thought of it as it's like a hive mind of people developing an entirely new architecture. It's not just a financial architectures or ownership architectures or trust architecture, it's a number of things. It feels like there's a hive mind of some of the smartest people I know, are all focused on it. It's a huge group of people. What are you seeing that's surfacing now out of this that's getting your interest? DAN MOREHEAD: The way I'd see it is in our seven years of investing, we've seen a bunch of different eras. The first year was all about just exchanges and custodians, and really basic ways to buy bitcoin and then ultimately ripple and Eth and other things and store it. That was our first year to these investments. Then the next level is using cryptocurrency and in most cases, Bitcoin originally, to do some cross border money movement thing. We're invested in probably 12 or 15 companies around the world that help people move money across borders. That's the thing is really coming into its own right now. It's really been effective. If you think about it, the average cost of remittances right now for the hundreds of millions of people that migrate to earn money for their families is 9%. You and I are in the financial markets, none of our base points, whatever. It's just a number. That's a month's wages, the migrant spends an entire month working for their remittance company, and their family only gets 11 months wages. The companies that are doing it with blockchain, essentially are the interregnum solution, like ultimately, people will just have blockchain on their phone and they won't need a company in the middle. For the next 10 or 15 years, they're going to use these companies that charge say 2% or 3%. They're seeing very, very strong growth. A great example of that would be 5% of US to Mexico remittance is going over Bitcoin right now. That's pretty wild, like it's a real use case. That's helping humans and saving the money, get more money back to their family. That's what's really happening right now. Then the companies we're funding our the next level of that, they're doing non-financial use cases, they're doing scaling solutions. The two biggest blockchains, Bitcoin and Eth, can only do seven or 10 transactions per second. In order to compete with credit cards, we have to do 15,000 transactions per second. If we want all the promise of micro labor, micro payments, we have to do orders of magnitude more than that. We're investing in a lot of projects that help scalability. Then as you and I know, there's a lot of plumbing to trading, order routing, order management type systems. Some of our most recent investments are in companies like AMBER and Tagomi that help traders trade these things and since we've essentially been there first at doing all these different things, we've had to prototype everything ourselves and so we had to build all our order routing and stuff. It's really hard. There's hundreds of exchanges that trade cryptocurrencies and then all these different regulatory environments where it's really hard to move money around. There's thousands of tokens you could possibly trade. It's a very complicated business and there's huge need for companies to help traders do that. There's journalists in this space, like the block that we're invested in. There's just a whole lot of different ways. We're essentially creating a new financial system built on blockchain. You need one of everything you have in the existing system. RAOUL PAL: How about custody? Because custody is one of the things that worries me in a solvency crisis as you and I've gone through many times is who owns all the shit in the end is one of the hardest questions to solve. How is the space working on this issue? Because trusted ownership is one of the great things about blockchain. Who's doing that for the securities industry and all of the assets that we all own in this? DAN MOREHEAD: In crypto, you're essentially custody-ing a password. You're really just trying to keep custody of the private key that can move the cryptocurrency itself. The custodians in the industry, like Fidelity or Coinbase, or Bakkt or BitGo, the hugely important thing about them is they employ no leverage. In the fiat system, you have Lehman Brothers or whomever that are employing 40 to 1 leverage across their balance sheet so when something bad happens, problems have nothing to do with the assets they're trying to custody, essentially just wiped through everything on their balance sheet. I think the hugely different scenario here is blockchain custodians aren't levered so there's no systemic risk. Then they're normally essentially isolated from the financial markets. There was a time when the biggest custodians of space, which at Mt. Gox, which at the time had 85% of market cap, they went under, essentially, without a ripple, the price of bitcoin was up a week later, there's no federal bailout of MT. Gox. It's because they're unlevered and not backstopped by the government that essentially keeps them safer. RAOUL PAL: What about the transition of the existing securities onto blockchain? What are the DTCC and people like that doing? I don't know what tZERO are doing. How does that evolve? Because we're going to have a need for that because we can't have another Lehman event and in a big solvency event that's potentially going on now, we're going to run into problems again. It feels like it's going to be the time and a place for blockchain to start doing that part of the custody. DAN MOREHEAD: It is, and one of the lines I love using about blockchain is that when a technology is massively disruptive, they call it a category killer. Blockchain's a serial killer. It's going to go through dozens of different industries, including securities, transactions and settlement. The hugely important part of that tagline is it's going to do it serially. It's not going to do everything overnight. We go through these manic waves in blockchain where in 2013 or 2017, everyone's thinking oh, blockchain is going to change the world overnight. Then we go on these depressive waves where oh, it's a failure, it didn't do anything. The reality is somewhere in between, and it's going to do different industries at different times, I have been of the belief for a long time that the Wall Street bit of blockchain, it definitely can happen, but it's like a decade from now. The reason is, it's just so complicated, and it actually works pretty well like you and I've been in Wall Street for a long time, you can bitch and moan about DTCC or whatever, but they process 100 million transactions a day with an incredibly low fail rate at incredibly low prices. Like all these-- TD Ameritrade, they're going to free trading, what's the problem with free in two plus two, it's just not that big. It's not broken. Whereas like if you're a migrant and you spend the entire month of January working for your remittance company, that's broken. I think it will transition to blockchain, but I think it's going to take a decade. There are some really exciting projects people are trying to do in this space but as a firm, we've essentially passed on all the centralized Wall Street back office blockchain projects.