The Deflationary Impacts of Bitcoin (w/ Will Peets)
TYLER NEVILLE: Here we are with Will Peets, CIO of Passport Digital Holdings. I'm really excited about this one, because we get to talk a little bit of macro. So, why don't we start out with the Passport view of the macro lay of the world right now? WILL PEETS: Sure. I guess there's probably a couple areas, there's the broader, traditional macro landscape, and then maybe that that pertains to crypto. I think what got us attracted to- or initially got our attention to digital asset space were a few themes that we were working on at Passport, one of which is the concentration of human capital, that's part of my Passport space here in San Francisco. But we saw a lot of really talented people moving into the digital asset space, whether that's working on a protocol or a company that's associated with the ecosystem. We've also been very focused on the broader deflationary impacts of technology. And we think cryptocurrencies and broader distributed ledger technology will have that same deflationary impact as you see with lots of other technologies. I think, also, just what's going on in the macro environment as it relates to indebtedness and amount of debt that's trading out and negative interest rates, it really starts to make you think about just the current monetary system, and if that's sustainable. And there's a lot of association with what you're seeing there, and in digital assets as well. So, those are all themes thatTYLER NEVILLE: Yeah, and I know John's main one is invest in things that haven't happened before. Right? WILL PEETS: Yeah, yeah, definitely. We've always been, I would describe it as the macro thematic firm, focusing on big secular changes. Clearly, technological innovation over the last number of years is a big secular change. Moving into a more deflationary environment, I think, is also a secular change. And there's this recognition by John, by the firm that oftentimes, the market's very poor at discounting events that haven't happened before. And so, I think as it relates to this space, large portion of the market's not paying attention to it. A large portion of the market doesn't realize the implications for what this technology will have and furthermore, doesn't realize how fast the change could happen. TYLER NEVILLE: So, in terms of deflationary themes, we're seeing yields dropping to their lows right now. And are you guys seeing a transfer from the public equity markets to crypto, is that what you're anticipating? WILL PEETS: Potentially. I think there's a few different layers of that. There's things like the sharing economy, which is allow for a more efficient utilization of resources and thus, you don't have to produce as more, or the cost of those resources goes down. So, you can see that in Uber and Airbnb, but economic models enable the sharing of a lot of the resources more efficiently, whether that's compute or storage, so that can have a deflationary impact on just the cost of things. Clearly, something like Bitcoin is deflationary by definition, in the sense that there's a finite amount. And then, yeah, as it relates to commerce or money transfer or remittance, clearly, there's large implications for any intermediary as it relates to digital assets. So, if you're a bank, and you're charging fees for remittance, or you just sending money with one another, stripping those fees out, because you have this trustless peer to peer ability to send value, that's another form of deflation. So, you see it on a lot of different levels. We we've looked at two different themes. And not to get too off track, but decentralized finance and what we call better finance, or better fi, and that's the application of the technology to the existing financial system. And you're seeing a security issuance, tokenization of real assets, trading of those assets, custody- all those things can potentially be done in a more efficient manner with distributed ledger technology. And again, that shrinks the margins of the likes of a State Street or Northern Trust, or these traditional banks and incumbents, again, which is all deflationary. So, from all the different applications and use cases, we see this technology is having potentially deflationary impacts. TYLER NEVILLE: So, let's talk about custody now that you went on to it. So, coming from big public hedge fund that you guys have run for years and years, the crypto space is a little bit untouched in terms of custody, are you guys- was your decision to get into crypto basically because that custodian feel is growing in the ecosystem is more secure? WILL PEETS: Our decision to enter this space was really first, the investment case for it, the investment thesis. I think, second is that we wanted to be an early mover and bridge institutional experience with what's currently a nascent asset class. And so, bring that expertise to this asset class and getting to be the bridge for maybe some more traditional investors to make an early investment. Clearly, there's opportunity in being a first mover. Certainly, the coming online of various custodial solutions exchanges makes it easier for us to do that, reduces some of the friction. So, that's part of the equation, and it's something that we've had to evaluate as we've got into this space. But yeah, if you believe in whether that's the potential for the technology and that institutional capital will come, certainly, custody is a requisite for that capital to show up. And so, we wanted to, of course, position ourselves before what we think this asset class will become much bigger. It is a little bit comical, in the sense that custody is unethical to the purpose of the technology, like you and I can have self-sovereignty over our assets, seemed capital peer to peer, but know and trust themselves enough to hold your own keys and not have the ability to call the bank and say, hey, I forgot my password. So, it's ironic from that perspective, but I think quite predictable and sensible if you really want to have the more traditional investors and real adoption of the technology, the capital to this space. TYLER NEVILLE: Are you guys seeing an easier time raising capital from the more institutional capital players? WILL PEETS: What I will say is that the dialogue over the last year has changed quite a bit. I think we've spent a lot of time educating the broader institutional investor base. TYLER NEVILLE: Endowments, pensions. WILL PEETS: Exactly. And then there's just a very notable difference year over year in those discussions. We've had a lot of groups that have come back to us, a lot of groups that have assigned individual or a team to do a deeper dive on the space. And so, again, the awareness, the knowledge, the understanding is materially higher than even just a year ago. I think it's becoming too big to ignore. And certainly, with Yale and a few other pension funds or endowments entering this space, that's eased. It's made it easier for others to reduce some of that career risk and headline risk of being the first mover into, again, a very new asset class where I'd say majority investing public is misinformed or underinformed at a minimum. So, yes, I think that's progressing. I think we would have expected it would have happened more quickly. But it's directionally going in the right way. TYLER NEVILLE: It's so funny. It's like back in 2017, I think that was the big theme, institution want is getting into it. But everyone moves a little bit slower than that. And now, it's actually coming in, and it's like, no one cares. They're starting to, butWILL PEETS: Yeah, and I think we've still just at the tip of the iceberg of actual capital coming in. There's been a lot of announcements over the last year about the likes of Fidelity and Bakkt and now, you have TD Ameritrade and Etrade offering. But those offerings are still in- they're just onboarding initial clients or they're only offering it to a subset of institutional clients. So, you really haven't seen the floodgates open. But you are seeing the groundwork as it relates to infrastructure being laid. And these people are investing a lot of capital, or these companies are investing a lot of capital to make these offerings available. TYLER NEVILLE: Do you ever ask them a question like you're investing in a bond that's yield 7% from an unprofitable oil shale company, verse a generational asymmetric upside. Does that conversation happen behind those doors- or? WILL PEETS: I think that's one of the difficulties with making the investment case for the asset class is what are the applications? And I think there's more applications that people are starting understand, but even if you appreciate those, and you appreciate that Gen Z is natively digital, and they're going to grow into the world where they had an iPhone and Day One and they're just accustomed to digital payments. And if you buy all that, then it comes to how do you value these different networks? And I think that's a big sticking point for a lot of people where I'd have to make any case to the investment committee as to why we should have a 50 basis points allocation. TYLER NEVILLE: How do you value them? Just in Passport size? WILL PEETS: Yeah, I think it's difficult. I think something like Bitcoin has potentially many different applications. And each of those applications, you could create a valuation model for, there's these different narratives. So, there's the digital gold narrative and this store of value that somewhere to gold is independent of the broader financial system. And so, you could look at, well, what is the valuation ascribed to Bitcoin if it's a certain proportion of gold or takes that role? You're seeing adoption in a lot of countries that suffer from economic instability and hyperinflation. So, Venezuela, Argentina, Zimbabwe, South Africa are all countries where you're seeing early adoption. And so, you can start thinking about it from the perspective of if Bitcoin replaces the monetary base, or the M1 in Venezuela, what does that mean for the value of Bitcoin? I think right now, if you were to replace, say, the top five countries by hyperinflation, it's roughly 12,000 per BTC, just as a point of reference. But then there's, again, a lot of applications of Bitcoin that people- I don't discuss much from an evaluation perspective. So, an example. Microsoft just announced this digital identity initiative and as part of that, I think they've announced a while ago, they just recently announced that as part of that, they're going to anchor this data set down to the Bitcoin blockchain. So, you're effectively just using the Bitcoin ledger as this immutable data store or you're taking a hash of this, your network, and you're writing that to the Bitcoin blockchain such that at any point in the future, I can look back, check that hash and see if anything has changed in this database. So, in that case, again, you want to use it for the utility of being an immutable ledger, you don't really care about the value of Bitcoin, they're being used as a store of value or money transfer. But you do pay a fee to write a record to the Bitcoin ledger. And there's a lot of companies whether it's Factum, this company based in Barbados called Bit that use Bitcoin in a similar fashion. And you'd have this third party, immutable ledger is a very powerful concept. And so, you use a little bit of Bitcoin to pay transaction fee to use that utility. And if you get a lot of adoption there, then that's its own valuation metric that you can use. And then you have lightning network, which is enabling payments on top of Bitcoin. And so, that could have a model that's maybe more comparable to a Visa or some other payments network. TYLER NEVILLE: It's fascinating. Yeah. WILL PEETS: Depends on how it's used, I think it there's lots of different narratives of what's the value of Bitcoin and it's varied a lot over the last 10 years, I think it'll continue to evolve. TYLER NEVILLE: So, how do you think about your portfolio specifically? And are you investing in tokens? Are you investing in equity of companies? How does Passport do that? WILL PEETS: Yeah, so the strategies that we run, first, focus more on token investments, whether it's liquid or just early stage blockchain companies. Going through last year, I think we've created- our view, there's a much clearer bifurcation between liquid in venture and so want to have a more clear distinction between those strategies. And this is, again, tangent of what I view the space as almost probably venture even though much of it trades just becauseTYLER NEVILLE: Liquid venture. WILL PEETS: Liquid venture. But there's this notion that if something trades, it means it's like a mature technology, like a stock is a private company, it is an IPO. And that is an acknowledgement that it's more mature, has revenues, what have you, debt of larger companies also trades as much more liquid. And so, I think there's a little bit of a misnomer on or misconception on the maturity of the technology in part because it trades and not just because its native characteristic of technology. It allows you to transfer value peer to peer. And so, as a result, you have to exchange these tokens and move them around. Where in reality, again, like most of the technology is still very, very early even for Bitcoin, which has been around the longest, there's still a lot of new applications that are being discovered today or envisioned today. TYLER NEVILLE: And you've even said we might even be in the first half an inning of an identity game, is that correct? WILL PEETS: Yeah, I definitely think we're still very, very early. People try to make analogues to development of the internet and the overall internet cycle. I think that's challenging. But yeah, we're still building base protocols for which other applications will be built on top of. One of the things that we're very focused on right now is investing in what I call financial primitives or these, again, very core base building blocks that will enable additional innovation and development. And so, because you're still investing in the equivalent of HTTPS, or FTP, that's where we are. And then, of course, as we've seen with the internet, a lot of things are possible once these protocols are in place, but we're still determining how many base protocols do we need? And what are the appropriate ones to use for certain use cases, et cetera? TYLER NEVILLE: And is the ecosystem- I think there's platforms like Tagomi now offer more custodial or institutional order management systems. How is that evolving? WILL PEETS: Yes, there's a lot of different platforms that are coming to market that are anything from order management to portfolio management systems to order execution. A lot of these groups are trying to pull liquidity and provide best execution. So, Tagomi, SFOX, FalconX, Routefire- there's a number of different groups out there that are offering some version of those types of services. I guess, as it relates to our own strategies, what we're most focused on his best execution and pulled liquidity. And so, whatever makes that the most seamless, and then you can trade the API or programmatically, that's a value to us. TYLER NEVILLE: Is liquidity there for big blocks? And who are the main providers of that in this space? WILL PEETS: Yeah. Certainly, there's a lot of OTC desks that provide liquidity for bigger blocks. In terms of the biggest players, certainly, Cumberland, Genesis and Circle are probably the first three that come to mind in the US that are large players there. You're seeing more traditional groups like Cisco HANA participate in the digital asset space as well. So, that's a growing universe for the first three I mentioned are some of the larger OTC desk that have been around for a few years now, few years plus. But then, if you want to be able to do that in trade programmatically, most of the OTC desks are still a Skype messenger or phone call type platform. So, they are moving to be more electronic and being able to do bigger size electronically. So, we're in this transition period right now, where even six, 12 months ago, that would have been difficult to do. TYLER NEVILLE: Stretching from liquidity to more institutional, are you seeing like, how big is players like Fidelity? Because you see a name like Fidelity is a trillion dollars in assets get into this space. Are we at this turning point where I think you said, these types of people are going to be forced to invest in crypto eventually, or have an allocation towards it? WILL PEETS: Well, I think longer term, there are probably a lot of traditional investors who will enter this space. Groups like Fidelity have invested a notice amount of capital creating the on ramps and being able to facilitate what they also perceive as future demand for more traditional investors. So, I think it's a great evolution, it's great to see someone by the likes of Fidelity enter this space. I think the other importance of them is that- so if you look at startups within the digital asset space, Coinbase is amongst the largest, most well-capitalized and name brand the people recognize, but they still are a Silicon Valley startup company. And that's very different than a Wall Street firm that's had 80 plus years. I don't know how long Fidelity has been around, but 80, 90 years of existence, and a really large balance sheet. And so, they're already have pipes and plumbing with large institutional investors, they have a balance sheet, they have name recognition and trust. And so, that's a game changing development for this space. And again, that's not a knock on Coinbase, or other well-established players, but it is different, like they are bringing, again, that Wall Street pedigree and familiarity. And so, it's interesting to see how that plays out, but I think, again, it's a net positive for the entire ecosystem to have the likes of a Fidelity and the likes of Bakkt whose parent is ICE enter this space, because it's clearly, they're taking it seriously if they're investing these types of dollars into it. TYLER NEVILLE: Are people using derivatives at all yet? Or is that still too early to futures derivatives? WILL PEETS: So, it's got two sides to that. There's derivatives offered on exchanges like BitMax, but they're offshore exchanges, largely unregulated. And so, there's a lot of derivatives volume happening there. You are now seeing the more derivative products on US regulated exchanges. So, again, there's a whole host of players, whether it's Seed CX or Aeros EX, that are again, registered license and are looking to launch derivative exchanges. I would assume that you're going to see options on futures contracts that are already listed on the CME at some point. So, that's coming. There's not really a lot of volume lease on the regulated exchange side yet for derivatives. Ledger X was actually one of the earlier US regulated participants that offers options. And, yeah, just for size, liquidity is still a limiting factor. But given all the different players that are entering that space, that's going to come as well. And that'll help the market as a whole as it relates to price discovery and just efficiency and risk management and number of other things, because right now, it's just very difficult to hedge a portfolio in part because things have to be fully collateralized or simply futures at 50% initial margin and so it's just it's capital inefficient to quickly hedge. Custody also creates a problem like that, because your prime broker doesn't have- well, they don't have the key, the private keys to your assets, so they can't pull back collateral if something moves against you on a futures position as an example. So, all those things that we take for granted in traditional and public markets are going to being rebuilt from the ground up. TYLER NEVILLE: So, fast forward five years- it's a tough question. But where do you see crypto? Where do you see public markets? WILL PEETS: Yeah. So crypto, I think, again, I think it'll evolve and have broad ramifications much faster than people expect. There's a hedge fund manager that's making a cheeky comment that the internet would have been developed much faster had you had the internet. If you had GitHub and all these tools that enable collaboration, it makes it much easier to develop and evolve technology. And so, I think we're starting in a point like Bitcoin was released in the age of internet, where there's already over a billion people who had access to the internet. When Ethereum was released, you're at close to 3 billion people who have access to the internet. I mentioned, again, Gen Z, this digitally native generation where everything that they've ever known is going to be something on their smartphone. And so, just the adoption, the innovation and the development can happen quite quickly. So, I think you're going to see a huge portion of total payments, for example, being done via messenger apps and the cryptocurrencies that are being integrated with those apps, whether that's Telegram or what Facebook's working on now. I think there's a lot of these decentralized finance platforms that allow for peer to peer lending, most of that right now is going to be overcollateralized loans that are collateralized by crypto that enable you to buy more crypto unleveraged or receive some liquidity without a taxable event. But as you enable different types of collateral, as you enable loans, they don't have to be overcollateralized, but are undercollateralized as institutional loans are today. You're just going to see an explosion in that market. And so, I would say, the next five years, the volume on those platforms will far exceed any of the peer to peer platforms that you see today, whether that's Lending Club or Prosper or patch of land or that type of business. And then as it relates to public markets- I don't know if your question was where I see as public markets going, or how I see this technology impacting public markets? TYLER NEVILLE: Yeah. Just the latter. WILL PEETS: On the latter, again, I think there's a company here in San Francisco called Figure and they have a blockchain called Provenance, but it's effectively a permission blockchain for the issuance and trading of securities. So, they're focused on home equity loan origination first and those chains are issued, excuse me, securities are issued on chain and they're traded, held with a custodian there, securitization will happen on chain. And all these things that are done now in the traditional loan market are being done on this potentially much more efficient permission blockchain. And so, again, as it goes to the deflationary impact of technology that we talked about earlier, that's Northern Trust, and State Street and all these incumbents that somehow participate in the ecosystem, and this technology has the potential to greatly create a lot of inefficiency or excuse me, efficiencies in that system. I think that's just one example of many where I think you're going to see a big impact on public markets. And that's either companies will adopt the technology, or they'll be just remediated or disrupted in some fashion. And then I think what's going on in just the broader global macro space is quite interesting as well. The existing financial system hasn't been around that long. And like this notion of QE in holding rates low, we're going to negative rates is not always just a big experiment. Because now, we have a lot of historic precedent to see how thatTYLER NEVILLE: 11 trillion in negative yielding bonds. WILL PEETS: Right, right. TYLER NEVILLE: How does that work? WILL PEETS: And so, it's not to say that human ingenuity, and central bankers won't figure out solutions for global indebtedness and these other things, but you can also paint a picture where this existing monetary policy doesn't work out so well, in which case, I actually think there's a lot of applications. That can be another catalyst for the adoption of some of those technology. And again, you're already seeing that in these countries that have hyperinflation, or just inept central banks and a lot of volatility in their native currencies. So, yeah, again, that's- who knows? But to your original point on do people invest on this as this asymmetric hedge? I think there is an element, if you have that dire outlook on the macroeconomy for any assortment of reasons. TYLER NEVILLE: One of the narratives, valuations. WILL PEETS: Yeah, exactly. That could potentially play into that. And that's actually really a catalyst for the whole space in some ways, like Bitcoin's being adopted in the likes of Venezuela for that use case. TYLER NEVILLE: Or China. WILL PEETS: Or China. Yeah, I guess that's another theme that I would be bullish on is like regulatory arbitrage. You're trying to control capital flows or cryptocurrencies. A solution around that potentially. But yeah, Bitcoin's been adopted in part because of this macro landscape and how it's impacting some of these EM countries. But Bitcoin has its own limitations, because it's volatile. And so, you're neither seeing a handful of stablecoins and a lot of other projects that are innovating on Bitcoin in some respects which potentially are a better solution for some of these macro problems. TYLER NEVILLE: So, I love the way you think about things at Passport. It's always very logical and makes me super bullish on what you guys are thinking so really appreciate it, I think it was awesome. WILL PEETS: Thanks, Tyler. TYLER NEVILLE: Really great conversation with Will. Passport is the best in the business when talking macro and it's really fascinating to see how their logic winds from public equity markets into the cryptocurrency markets and it's really going to be interesting to see where things are in a couple of years because I'd imagine they're at the top of the pack.