Is the Big Money Heading for Bitcoin? (w/ Meltem Demirors)
JUSTINE UNDERHILL: Meltem, thank you so much for joining us. You have quite the varied background. Could you take us a little bit through it? You actually started out in oil and gas, is that correct? MELTEM DEMIRORS: That's right, that's right. So I started my career trading commodities. I traded ethanol and methanol. And then got into trading carbon credits when those were a thing, I guess a fad if you will. And so then spent some time in oil and gas M&A from 2009 to 2014. I also spent some time working in corporate treasury for one of the major oil and gas producers, Exxon Mobil. And after spending the early part of my career in commodities, oil and gas, corporate finance, went to graduate school, where I got excited about bitcoin and fintech. And from there I guess things just went downhill. Or uphill, if you will. JUSTINE UNDERHILL: There's actually, I noticed that you're on the World Economic Forum Blockchain Council. What exactly is that? What do you do there? MELTEM DEMIRORS: So I started working with the council when it was first formed in 2016. And they recently took the last two years of work that had been done via that council and created a center for the Fourth Industrial Revolution, which is based in San Francisco. And they've honed in their focus on AI, robotics, blockchain technology, and four or five other areas,-- And are really actively focused on really helping policymakers, decision-makers, corporate executives, governments, understand what's happening with this technology, work on small scale pilots, and then put together frameworks to help regulators implement new policy and new governance that will help provide sort of safeguards for this technology to grow. As you know, the blockchain ecosystem and the cryptocurrency ecosystem in particular have really struggled with the lack of regulatory clarity over the last few years, particularly now as the market's growing and there's much more demand from not only investors, but also corporates who are looking to adopt this technology. And so the goal is for this WEF council to play a role in helping push forward, and just providing a trusted resource and a trusted group of individuals who can help steward some of that process. JUSTINE UNDERHILL: And that's going to be key for getting institutions more deeply involved. And that's something you've been working on quite a lot. MELTEM DEMIRORS: Well, I would say the institutional side of this business has been the most interesting side. Cryptocurrencies are unique, because they're very friendly to retail investors. And with most new asset classes, what typically happens, is these asset classes are first popularized with institutional investors. Typically there are specialist hedge funds that emerge or alternative asset managers that emerge, and these asset classes are typically really oriented towards institutional audiences. Here what's happened is the inverse. Crypto started with retail investors. It started with a group of people on the internet. They made this magical internet money, if you will. And over time, it's flourished and developed really outside of regulatory bounds in most cases. And so now that institutions are looking at the asset class, we're going sort of in the inverse direction that we've gone historically. And so what I think's been interesting, is institutions are trying to number one, think about how to manage risk in this new world. There is financial risk. There's a lot of reputational risk. But there's legal and regulatory risk as well, given the lack of clarity with regulators all over the world. And so there's a lot of nuances and pieces that need to be figured out. What I've seen so far though, I mean just this year alone, we've seen a number of really exciting announcements. Fidelity is now custodying digital currencies, primarily Bitcoin, for some of their larger clients and asset managers in this space. We've seen that ICE, which is New York Stock Exchange's parent company, last year launched a new subsidiary focused on digital currencies. They're going to be issuing their first physically backed bitcoin futures product, which is exciting. CME has had their cash settled bitcoin futures product in the market for about two years now. But they're trading record breaking volumes on that contract. So I think slowly those pieces are starting to fall into place. But with most regulated financial institutions, it's typically one player moving forward, and then everyone being a fast follower. JUSTINE UNDERHILL: So as someone that's actually, you've been personally investing in these coins and cryptocurrencies, what do you see as the right allocation for crypto? Especially looking at it from an institutional perspective, there are certain allocations to different risk assets. Where does crypto fall into that? MELTEM DEMIRORS: That's a great question, and I think that's a question where one of the things we sometimes forget in crypto that I try to be very mindful of, is cryptocurrencies fit into sort of a larger macro narrative for investors. And so it's interesting how cryptocurrencies, particularly bitcoin, and if we think about the cryptocurrency market, the way I categorize it is, there's Bitcoin, which today is over 50% of the market in terms of market cap. Then there's Ethereum, which is around 5% to 10% of the market. And then there's everything else. And there's a long tail of other assets. When it comes to allocating to these assets, it is my belief and our belief as an asset manager, that the majority of interest is still in Bitcoin. Just because it's best understood. There's the most educational material available around Bitcoin. And some of the fundamentals of Bitcoin are very similar to the fundamentals of gold or other physically scarce assets or produced commodities, like oil and gas, which is also physically extracted. And so to us, Bitcoin's really the first asset that investors are getting interested in. And then there's this long tail that's much more speculative, where we see a lot of specialist emerging managers focus on creating hybrid hedge fund venture fund style strategies to invest in these new and emerging cryptoassets with the hope that they'll see 100%, 200% appreciation over a short period of time. But when we think about really large volumes of capital flowing in, I think the predominant narrative right now is still Bitcoin. JUSTINE UNDERHILL: Mm-hmm. MELTEM DEMIRORS: And I think what's interesting to think about is, many investors who've been getting exposure, started by doing it through a side pocket or maybe they did it through personal exposure. Family office of a CIO or a manager of a large fund getting exposure first. And it really started with education. So many macro fund managers who took an interest in Bitcoin in 2017 started maybe writing research on the topic. Maybe they had a small group of two or three traders getting familiar with the venues where these things trade, how execution works, some of the nuances of managing this new type of asset. And just now we're starting to see macro fund managers get interested in potentially adding exposure. But I do believe at this point in time, the majority of the exposure is still Bitcoin. And a lot of it's accessed through products. And we have an exchange traded note in the European market through our XBT provider brand. That's been really popular with managers in Europe. We see the same with the grayscale products here in the US, similar construction. And then I think we're going to see a number of new products launch that enable investors to get managed exposure. And particularly, abstract out some of the complexities of adding cryptoassets to the infrastructure of an investment firm. JUSTINE UNDERHILL: So still the early days in-- MELTEM DEMIRORS: Early days, yeah. JUSTINE UNDERHILL: Now what do you see as the boom bust cycle for bitcoin specifically? And do you see that as uniquely different from other assets or other technologies? MELTEM DEMIRORS: I think look, markets are cyclical. This is one thing we know. And one thing we've certainly seen in digital currencies is this pattern of rapid inflation in prices typically driven by news. One of the interesting things people always ask me, well, what are the fundamentals that substantiate value for digital currencies? And the answer is, most of it's driven on news cycles and confidence. Confidence of investors and participants in the industry. And it's not so different from public markets. What gives something like Tesla its value? Obviously, that's a little bit different. It's a public company that has reported financials. But the great thing about digital currencies is, all of these metrics around the digital currencies themselves and the networks that support them, they're public. So people are extracting all sorts of different data points from these blockchains. People are creating all sorts of new metrics aside from just price and market cap and daily traded volume to try to understand how these things are actually being used, trying to create new fundamentals and formalizing them through a lot of this research that's being written by investors and investment managers. But I think the challenge is still, there are these waves of news that are typically driven by positive market events. For example, financial institutions adding digital currency offerings to their suite of offerings was a great news cycle in the earlier part of this year. That drives more investor interest. It helps sort of create legitimacy, if you will, for the asset class. That in turn, leads to more investors rushing in. Historically the booms and busts have been driven by retail interest and retail bringing money in. But what we're seeing in this cycle is, there seems to be more of an inflow of institutional capital. So that's exciting. But typically what happens is, people all pile in, they're excited about it. Expectations get overinflated. We see a bit of a spike or if you will, a bubble. Expectations realign as people realize it's going to take quite some time for the technology to catch up to the expectations people have. Then you see a return to reality. You see the real value of these assets align more closely with what's actually feasible. And then we repeat that cycle. JUSTINE UNDERHILL: Do you think the technology is there yet for bitcoin, for crypto? MELTEM DEMIRORS: Sure. I mean, one of the interesting conversations we have is, if bitcoin never changed, would it still have value? And I think the answer to that at this point is, definitively yes. Bitcoin has proven that it functions well as a store of value. And so the way we often talk about bitcoin is as digital gold. And a lot of people who hold bitcoin, really what their interest is in having an alternative to holding fiat in a bank account. Instead of holding US dollars in a CIS bank account, you can now hold bitcoins in a wallet that you control the keys to. And it's secure, it's resistant to being seized, which is a narrative right now that's particularly relevant with what's happening on the global stage. But I think the narrative is still very much around viewing digital currencies and bitcoin in particular, as a hedge to political risk. What's interesting to see though, is as part of the cycle of bitcoin maturing and the technology evolving, that narrative starts to change. So in 2016, when the Ethereum network launched for the first time, this idea of smart contracts or the ability to issue assets on a digital medium and have programmable money or programmable assets was popularized. And that led to a whole new wave of innovation. Part of that innovation was new financial products being created, a new type of assets being created. What we're seeing now with bitcoin, this layer two of the bitcoin network called the Lightning Network, which facilitates payments in real time that are instant, that are fast, that aren't dependent on the base layer of the bitcoin blockchain, which tends to be slow, has a 10-minute block confirmation time. That's facilitating all sorts of new use cases. And that in turn, drives a lot of interest from investors and opens up the realm of possibilities in terms of what can be built on top of the technology. JUSTINE UNDERHILL: You mention bitcoin as a hedge against political risk. You actually have a really interesting story as to how you first used bitcoin that relates to that in a certain way. MELTEM DEMIRORS: Absolutely. So my family, I grew up in the Netherlands, but my parents are both Turkish. And not only are they Turkish, but they're both from the same small village in Turkey, about 2,000 people, and it's about an hour north of the Mediterranean. So near Antalya, if you know Turkey. But what was interesting for me growing up is, I lived in a world, first in the Netherlands, and then in the US, where I never really thought about money or my ability to access money. I had a credit card. I could go to the ATM. You didn't really think about accessing the financial system. But what was interesting, is trying to interact with my family in Turkey, they lived in a village that had no electricity, no running water till I was a teenager. And even then, there wasn't a bank branch in that village. So you would have to drive to a town 30 minutes away to go to a bank branch. So in our minds, many of us, we can't really imagine that type of world. But for me, this was very real. And so what became interesting to me when I first started learning about bitcoin in 2012, this idea that anyone with an internet connection and the ability to download this open source software client, can now interact with the bitcoin network. That is fundamentally transformative. If you think about, I remember the day as BitTorrent and Napster and LimeWire, when people were sending files. Or even when you first started sending emails. That's fundamentally transformative. And I think this idea of peer to peer digital money that is borderless, that is supranational, meaning it's not tied to any one state or anyone entity, and is not controlled by one specific individual or one specific group, that's a really powerful concept. And to me, that's what really made bitcoin click for me. JUSTINE UNDERHILL: Mm-hmm. MELTEM DEMIRORS: Now there's a lot of challenges. How do you get money into and out of the system? How do you get bitcoin in the first place? There's still a lot of these on and off-ramp questions that need to be resolved. What do you actually do when you have bitcoin on the network? How do you safely store it and manage it? A lot of these challenges are what many of the startups building around this technology are trying to resolve. But the fundamental idea is an extremely powerful one. And I think again, it's part of this broader narrative and this broader story arc we're going through right now, which is the evolution of how we live. We've gone from existing in the physical world, interacting with physical money, with paper stock certificates, with face to face interaction to doing more and more things online digitally and thinking more about privacy and our rights when we go online and engage and transact and communicate. JUSTINE UNDERHILL: So you don't have to, I mean, that's sort of the what bitcoin has been built up on, is that you don't have to rely on one bank or one centralized authority. But do you still see areas of systemic risk even within the crypto community, even within the crypto space itself? MELTEM DEMIRORS: Oh, absolutely. It's still an experiment. I think this is the though one caution I always give, is this is still an experiment, and this is a binary investment. This is either going to zero or a whole lot more than zero. And there's really not much in between. JUSTINE UNDERHILL: Even Bitcoin? MELTEM DEMIRORS: Yes, absolute. I mean, look, this is very experimental, it's very high risk. I recommend people only invest what they're willing to lose. There's, and what's unique here, is there's technology risk. There's network risk. So there's the protocol in the code itself, which is maintained by a group of developers who contribute to this open source project. And open source is nothing new. It's been around for a long time. But what's interesting here, is its development of money. So the stakes are much higher. The politics of it are much more heated, I would say. And we've seen this over the last few years, the dialogue happening within bitcoin and the splintering or forking of the bitcoin network into multiple different networks with very different visions. And then you have the network itself, which once the code is written, people have to run it. And there are tens of thousands of nodes around the world that run copies of the bitcoin software and store copy of all of the history of the bitcoin network. So a great example is, it's like if you wanted to send an email, you'd have to download every email that's ever been sent. It's pretty intensive. It's expensive. Our firm, CoinShares, has done a lot of research on the economics of bitcoin mining or supporting the bitcoin network. And so bitcoin does rely on increasingly more and more computational resources being contributed to the network to keep it secure. So there are fundamental questions around the security of the bitcoin network. And in fact, national security agencies like DARPA, have been doing a lot of research and have a research lab dedicated to the development of these new communication networks that are cryptocurrency-focused. And then there is also the application layer. So how are people going to interact with digital currencies? If a regulator somewhere decides that they no longer want to allow digital currency exchanges to operate, what does that mean for the system? If all of a sudden those fiat on-ramps are removed, which again, we've seen in the past when, for example, the Chinese government cut off access to banking for Chinese exchanges, that can have material impacts on the market. And so there are a lot of risks. But I think for a lot of investors looking at this space, there's just a tremendous amount of opportunity. JUSTINE UNDERHILL: Now I got to ask, Facebook. MELTEM DEMIRORS: Yes. JUSTINE UNDERHILL: And the coin that they're developing, it's funny, because this is a, seems to be a private centralized controlled coin. Does it really have that much to do with crypto? Is it's something that the crypto space can really use or leverage? Or does this really do anything? MELTEM DEMIRORS: No. So here's my take on Facebook's project. It's called Libra. So first and foremost, on the way Facebook's going about it, and we'll learn more in the near future when they released the technical white paper, but what we know so far that can be publicly shared is this. Number one, really what Facebook is attempting to do, is to create a stable coin or an asset that has relative purchasing power parity stability. So bitcoin as we know, is volatile in price. Just in the last three months alone, it's doubled in price. But we've also seen periods where it's lost 80% of its value. So for your average user, it's not necessarily the best asset to hold when it comes to being a medium of exchange or unit of account. People seek stability, which is why so much of the world has been dollarized in many ways. So what Facebook is attempting to do, is to compete really with the US dollar in the existing correspondent banking system. What I do think is interesting about what Facebook is doing is this. Number one, Facebook has 2.5 billion users around the world. So if you think about the distribution of this, the potential is absolutely massive. Today, the estimates for active cryptocurrency users, which come from the research done by Cambridge. They do an annual user study around bitcoin in particular, is anywhere between 30 to 100 million. Facebook has 2.5 billion users. There are only 3.5 billion people, only 50% of the world's population's online. So Facebook's ability to bring the idea of digital assets or digital currencies to a whole new audience, I think is absolutely massive. Because they're going to have to educate this audience on what digital currencies are, how they work, what a wallet is, how a wallet works. And all of these things in my view, are net positive in helping spread awareness and education. That's one. I think the second thing that's really important, is for corporates all around the world, they're all looking at this. And I can imagine that in every boardroom across the world right now, corporates are asking themselves, what does this mean for us? We've already seen this reflected. Square is hiring a crypto-focused team. Jack Dorsey himself has stated numerous times that he believes in the potential of bitcoin to be the currency of the internet. And the Cash App, quarter over quarter is doubling revenues. And so I think that's a really positive signal. So Square has chosen to focus on bitcoin. Microsoft is doing a lot of development work on top of bitcoin. But then we see the Japanese ecommerce giant, Rakuten, they're developing their own coin to embed into their rewards. Ecosystem they do about $9 billion of rewards compensation through that system every year. And they have 250 million users. So there are a number of other corporates who are experimenting with this idea of a coin in some form. Now what I think is interesting, is Facebook really adds fuel to that fire. And then the third piece is, we can't forget that Facebook is a company in crisis. Cambridge Analytica, even though that happened 18 months ago, the stock price still hasn't recovered. There's a lot of pressure on Facebook to do something about the perceived privacy violations it's engaged in, as well as this risk of centralization. We saw GDR being implemented in Europe, leading to huge fines. That's just starting to happen. Here in the US, privacy regulation is big on the agenda of every regulator and every politician. Going into the 2020 election, Facebook and every social media company is a political punching bag. JUSTINE UNDERHILL: Mm-hmm. MELTEM DEMIRORS: And so for Facebook, introducing this new concept, saying it's somewhat decentralized to this external foundation they've created, allows them from a crisis communication perspective, to create a new narrative. JUSTINE UNDERHILL: But it's still, in some ways, surveillance capitalism, in the sense that they know what transactions are going on. They are basically the ones watching the blockchain. MELTEM DEMIRORS: And I think that really to me, is going to be the most interesting aspect of what happens here. To me, this is less about payments and this is more around data. We've already seen the coupling of your social data with financial data. Google, back in 2017, introduced a product that coupled your credit card transactions through Google Pay with the data around your search engine behavior and other data they gleaned about browsing behavior, which is really powerful in terms of encouraging retailers to spend on advertising. The ability to now couple of that behavioral data with the spending data. And so what I think will be interesting, is Facebook, 2.5 billion users across not just Facebook, but also Instagram, which is increasingly focused on direct to consumer sales and becoming a shopping platform of its own, as well as WhatsApp. WhatsApp has historically been free. And so the idea that you could now monetize WhatsApp and enable people to send payments through it and capture valuable data streams about their relationships, but also by the way, enabling governments to censor those flows of value, depending on the status of particular users, be interesting. And then the last piece that to me is fascinating to watch, Facebook doesn't have a universal identity system across its platforms yet. And so with the introduction of a new payment mechanism, what they likely will do, is also roll out a universal ID that links together someone's behavior across all of Facebook's disparate platforms, links with that transactional data, and allows them to capture a lot of really rich information about people, their network, their social interactions, their browsing behavior, and how they spend money. JUSTINE UNDERHILL: Finally, what do you see as the biggest risk to the crypto space overall, in the next five years, 10 years, long run? MELTEM DEMIRORS: Yeah, I think there are two main risks in my mind. The first risk is really regulatory risk. For this to continue to grow, for this market to continue to develop, there needs to be clearer regulatory guidance. But also within the industry, I'm a fan of self-regulation. I think a lot of times early industries can't rely on regulators to keep pace with what's happening, but have to self govern and adopt standards of behavior, transparency, et cetera. So I think there are a number of projects underway in the crypto community that are trying to create transparency and trying to create reporting standards, disclosure standards, for how people engage, that brain trust. I think one of the big things here is investor trust. A lot of it was lost in 2017 and 2018 when there was this crazy bubble of just absolutely ridiculous meritless projects raising capital through this new strategy called an ICO or initial coin offering. Many of those have now lost 95% or more of their value and have no chance of ever returning value to investors. So I think the industry itself, self-policing a bit more, being a bit more proactive, and then working collaboratively with regulators to introduce some new standards that are not to burdensome, but still provide investor trust and transparency, I think that's key. I think the second component, really again, is zooming out and looking at the macro environment. Crypto doesn't operate in a bubble. And in the last five years, there have been periods where crypto is, and bitcoin in particular, is a risk on asset. And there have been periods where bitcoin is a risk off asset. There are periods where it's positively correlated to the S&P 500. There are periods where it's negatively correlated. So it truly is in many ways, an uncorrelated asset, but it does respond to macro events. If you look at what's happening in the world today from a political perspective, there's a lot of political tension, the breakdown of the European Union and that economic zone and Brexit are having huge impact. What's happening between China and the US in terms of trade wars is having a huge impact. You can't really look at bitcoin in isolation of these larger macro events. So there are political events. There are also economic events happening. We look at what's happening here in the US. The Fed is looking at potentially rate hikes. We're looking at inversion of the yield curve for the first time in a long time. And then we look at the broader macro scale. If you're an allocator looking at the world today, there's not a lot of yield out there. Everything's overvalued and everything's overbought. There's way too much money and not enough places to stash it. You look at the rise of tech startups. You look at Silicon Valley. You look at the growth of venture capital as an asset class. It's the perfect indicator to me, or a canary in the coal mine, if you will, of what's ahead. And so I think looking at bitcoin through that lens, you can start to see how to some allocators who are looking for a yield, an asset like that could be extremely attractive or an environment where they're looking to shed risk could be extremely unattractive. And so for us, it's very important to keep an eye on the macro environment, but particularly what's happening in the political arena and what's happening economically. $9 trillion of negative yield debt is insane. It's absolutely insane. And so it's important to put bitcoin in that context and view it through that lens as well. JUSTINE UNDERHILL: And then also at the end of the day, making sure that the technology is matching up with the amount of money that's flowing into it. MELTEM DEMIRORS: But look, at the end of the day, markets are irrational. Investors and humans are prone to all sorts of ideological fallacies. And so it's not our job, speculation happens in all asset classes. There are bubbles in all asset classes. There are times when certain asset classes see crazy amount of inflation or a crazy amount of speculative growth. And so I think at the end of the day, there's little we can do to keep investors from speculating on these assets. After all, a digital currency as bitcoin is a gambler's paradise. And traders love it. There's volatility. So when volatility seeps out of commodities market, people come to crypto, because the vol is there. When the vol leaves crypto, people go back to commodities or equities. Traders are going to get their fix where they can get it. And speculation is a large part of our capital markets today. So I don't think that component's going to go away unfortunately. JUSTINE UNDERHILL: Meltem, thank you so much for joining us and giving us all of your insights, and we look forward to having you back on soon. MELTEM DEMIRORS: Thanks for having me, appreciate it.