Cryptocurrencies Trading Strategies | Risks and Opportunities with Crypto Fund Manager Ari Paul

what's up everybody welcome to another episode of hidden forces with me dmitriy kapinas today I speak with Ari Paul R is co-founder and CIO of blocked our capital one of a number of newly minted hedge funds focused exclusively on the cryptocurrency space he was previously a portfolio manager for the university of chicago's eight billion dollar endowment and a derivatives market maker and proprietary trader for Susquehanna international group in our most recent episode with crypto fund manager Chris furnace key we learned about the models that some of the most forward-looking investors are using to value crypto assets in this episode we learn how to trade them how does a crypto fund manager manage risk and what are the existential risk factors to such a new and fledgling market what are the benchmarks for measuring performance is it Bitcoin crypto currencies or the broader equity markets how do you seek alpha in an already uncorrelated asset and how might the flood of institutional capital alter these correlations what does a consolidation in cryptocurrencies look like are we verging near a collapse in valuations and if so what sorts of tools are available for shorting on overheated market we look at cash-settled futures the use of put and call options and consider how to protect ourselves from counterparty and exchange risk finally we examine some of the most interesting and creative investment opportunities for making money in this emerging market and what you can do to take advantage of them as always you can join our email list by visiting the show's website at hidden forces pod com if you listen to hidden forces on your iPhone or Android make sure to subscribe if you like the show write us a review and if you want a sneak peek into how each episode is made or for special storylines total pictures and questions then like us on Facebook and follow us on twitter and instagram at hidden forces pod and now let's get right to this week's conversation ari welcome to hidden forces thanks for having me Demetri it's great having you here so why don't we start with your background how did you get into this space so my background was first as a traitor at suspender national group as a market maker commodity FX trading kind of anything and everything and then as an asset allocator universe chicago endowment so i think of it as kind of the too far into the extremes of investing one is the very short term trading and the other is long term asset allocation so how would you describe what you're doing now so I run a crypto investment firm that has one product which is a hedge fund and it's definitely more active trading focus than most crypto investment funds in the space and what that means is we do a lot of event-driven trading for example we'll make trades based on hard Forks or conference events so I think of it as really the intersection of an understanding of cryptocurrency fundamentally with the trader mindset of always looking for edge what is our alpha what edge do we have over the competition over the market how many partners do you guys have so I've one co-founder as partner and then we currently of a team of eight people in total hmm there are a lot of funds now kind of opening up in this space and you guys in my correct you raised 140 million in one particular round with Union Square Ventures and dreesen Horowitz we actually raised much less that we launched with only less than ten million dollars back in August we raised another roughly 40 after that and then we grew to that one forty number very quickly just because frankly the whole market was up mm-hmm yeah I mean there's a tremendous amount of interest in this space so that kind of gets to the question I wanted to ask you off the bat which is what type of returns are you looking for like what are you looking to to gain in this market so very broadly what I'm trying to accomplish is really to capture the upside of cryptocurrency with far far less risk and what that means and practice is when we have a period like in the last quarter if the cryptocurrency market as a whole was up roughly 2x it depends on which kind of things you look at if you look at Bitcoin and kind of large caps it was up to X 3x so our focus is really during a raging bull market we want to capture that for investors we're really focused on the fact that they're bear markets – and this is a market that a bear market does not mean down 10 or 20 percent it can mean down 80 percent so we're really focused on mitigating risk mitigating that downside so when people talk about your target return to me as an investor that's actually a really bad question I don't I don't believe in targeting return I don't think you can target return I think what you can do is target risk and so we try to really minimize the risk of ruin to bring the probability of say a 60% draw down as close to zero as we can and then within that constraint we're trying to maximize and what that means and practices when there's tremendous opportunities we're trying to make every penny we can but if you tell me that there's gonna be a bear market that's gonna last a year and everything to be down 70 percent and maybe the arbitrage opportunity it's hard to generate alpha my goal in that scenario is to lose as little as possible my target return might be zero so there are a number of really interesting points you're bringing up there one is that you're touching on this this thing of benchmarks which is that traditionally a hedge fund gets graded on how you perform if you uh perform in the market but in this case you don't just have that before in the market you also have to perform the cryptocurrency space in general right yeah no one's impressed I mean some cryptocurrencies Bitcoin – yes I mean in a period where cryptids of 100% no one's impressed you outperformed Treasury bonds or even equities right so it's a really challenging question what is the benchmark because the simple answer might be say Bitcoin but a year ago Bitcoin was 75 percent of the market now bitcoins about 30 percent well what if Bitcoin Falls to 5 percent what if aetherium conquers the world what if something that has yet uninvented conquers the world none of our investors gonna be happy that Bitcoin went to 0 let's say and we were down 90 percent neither knowns gonna be happy about that so I like to joke that we're benchmarked against whatever wins with hindsight bias hmm well that's interesting too right because if it's something that hasn't been invented yet how do you guys get exposure to that and we'll get we'll get into that because I mean well there's like tons of interesting questions I had for you so getting back to return and risk there's a lot of volatility in this market that's one of the things that makes it really attractive and we'll get into sort of how you can play that volatility and capture a lot of spreads there because there are many but that's obviously something where your investors have to be aware of that level of volatility and what are your can talk about lack of provisions and like how do you like manage your capital this is the same as any other hedge funder sure so the regulatory rules in the space or you're really not supposed to talk about okay an investment vehicle but what I can talk about is our investment approach which is almost the same thing and the idea there is just you're not supposed to market really so the way I like to approach the space the way I want invest my own money frankly and that's how we do everything it's very much most my own money is invested with us and I want to invest our investors money the same way my own money's invested and the thinking there is I'm very confident in both the beta tailwind I'm confident two currencies whole will succeed I'm very confident our ability to find high alpha opportunities but just to clarify for our audience by the beta tell when you're talking about the exposure to the cryptocurrency market in general and basically getting catching that entire wave and then also having the opportunity to rewards on top of that beta with alpha which is what you're referring to there exactly exactly so total cryptocurrency Network value I'm confident gonna be higher now I say confident doesn't mean – sure thing that's it that we're making that's a bit anyone who investment this is making if you think cryptocurrencies going to zero you don't allocate to cryptocurrency and then and we are confident that it is an inefficient market and there's opportunity so I say that so what's our focus our focuses that's why we're inordinately focused on avoiding those big draw downs because it's this idea that as long as we're in the game we're gonna end up happy right so we want to make sure that we stay in the game and that means avoiding blow ups of any sort and that means extreme draw downs due to market risk it also means security right so avoiding having our assets stolen it means counterparty risk so if I had all of my assets sitting on one exchange and that exchange gets taken down or hacked or bankrupt so we're very focused on making sure that we don't have any extreme losses so you're like touching on all these questions that I already have for you Ari and you're throwing me off a little bit but I definitely want to get into exchange risk and counterparty risk in general also I'm curious to what extent you can use leverage given the liquidity in this market but before that why don't we take a step back here why don't you walk me through your investment framework sort of what you feel differentiates both crypto funds in general and this industry because one of the things I was thinking about in this brings us back to beta and alpha is that if you know traditional fund managers some fund managers might be trying to get exposure to cryptocurrencies in fact I heard you mentioned this yourself about you know when you were at the endowment that it would have been potentially a good move certainly in hindsight it would been a good move for the Chicago School endowment to have some exposure to Bitcoin and then in fact weirdest cryptocurrencies that in fact this provides a certain to quote my friend Christopher Cole it's like adding Dennis Robbin to your portfolio it gives you exposure to convexity now you're already in the cryptocurrency market again that brings us back to beta like which is your beta so I don't know walk me through your your framework here and yeah I'm free to geek out with me yeah sure sure so there's no right answer to the product that investors wanna invest in so within the asset allocator see a question we often ask that the endowment was do we want that at the hedge fund manager or investor to be responsible for timing the market or for deciding so for example let's say you write a check to a real estate manager is it their responsibility to foresee the 2007 and a downturn in real estate of course all right didn't you know that well the challenge though is is look at look at it from the other side let's say I'm an endowment and I want 10% of my portfolio in real estate and I write the check to the real estate manager in the real estate says you know we think things are frothy we're gonna hold 80% cash they've kind of destroyed my allocation decision right so it was my decision decide how much I want allocate to real estate I see what you're saying so there's an argument to say that the job of a fund manager is do the best they can relative to the benchmark relative to right you know person who invested in them is deciding how much worse they want to take do they want invest 2% of net worth or 10% in that asset class that's fine we don't do that so what we say is there's a lot of people who unlike in traditional asset classes most people feel like they have some sense of equities right we all know what a p/e ratio is most people who invest in a real estate fund have some sense of real estate and valuation most people invest in cryptocurrency including a fund like ours kind of know that they don't know and they're looking for us to make not only the kind of alpha decisions but also the beta they also want us to time the market and again not I'm not saying that's the right answer for every every fund and every firm but that is what we do so we typically hold a lot of cash we target something like 40% cash on average we trade in and out of that aggressively so yes about leverage so no I want to deleverage because cryptocurrency is so so volatile and so risky kind of his leverage already incredible energy it's like a call and so I'm far more comfortable managing a portfolio that's a little bit D leveraged and I'm very confident that there's enough alpha opportunities that we're still gonna end up producing really really attractive returns for investors despite having that cash drag so you said it's like a call are you able to use puts and calls in this market you can so I believe that I have actually personally traded the majority of all the calls that have traded in the space and that sounds like a silly statement but the reality is that almost no options have traded so we did a million dollar options trade that in our minds was not a big trade or meaningful trade was a very small percentage of the portfolio in corner that are getting it was funny because it got written up on by the Wall Street Journal as anonymous trader makes massive million dollar bet that the coin was fifty thousand dollars and I read that it was like disbelief it was like oh that was like just a tiny bet for us but also didn't properly capture all so can you explain to our audience how put works and how call works what the difference is and how you would use it and why that doesn't necessarily reflect that you're going long you know that you need a payout of fifty thousand price of Bitcoin in or your fun to be successful or to have a successful quarter whenever sure sure so a call is the right but not the obligation to buy something that put is the right but not obligation to sell something so let's use a concrete example so if Microsoft's trading twenty dollars I can buy the twenty five dollar Microsoft call maybe for a let's say two dollars so if Microsoft goes to $30 I then have the right to buy Microsoft stock for twenty five I paid two dollars for that right I then get to sell Microsoft stock at thirty so I make five dollars minus two dollars I get three dollars a profit so a call is potentially a less risky way to have access to upside you're kind of borrowing money from the person that you're getting the stock from not this part from you so it can be a way to get leverage it can be yeah it can be capital efficient it can be a way to limit your downside risk so in that scenario the most immersing is two dollars so Microsoft goes to zero I still lose two dollars but I think something that people often miss is there's this term called put-call parity so the way you actually price it put in a call I'm gonna oversimplify a put is a call because you can trade the underlying and convert one into the other so what that means is I can buy a call I can then short stock and it is identical to if I bought a put so to an options trader a call is not a bet on something going up the call is about on volatility and the reason for that is I can buy a call short the stock and hedge out the Delta I can hedge out the upside exposure so what am I really betting on if I buy a call I'm betting that the stock is gonna move along and I don't care if it goes up or down I'm betting that it's just gonna move a lot then there's kind of a second derivative so not only i betting that it's gonna move a lot around where it is now if I buy a deep out of the money call so instead of buying the $30 Microsoft call let's say I buy the $80 Microsoft comb the way that's priced relative to the $30 call is a bet on the shape of the distribution right as a term called fat tails or kurtosis so that $50,000 strike call so what I did is I bought basically a million dollars of calls that settle at the end of 2018 third of the $50,000 striking Bitcoin I did that when Bitcoin was trading around eighteen thousand dollars and so one way to think about is I'm betting Bitcoin will go higher but I could just buy Bitcoin if I want to make that bet and I can hedge that part of the calls another way to frame it is that I'm betting the bitcoins gonna be very very volatile if it goes down a lot that call actually makes me money because I own less Bitcoin because I have the call so I lose less on the way down then there's another way to look at it which was definitely part of my thinking which is an idea of the shape of the distribution just to clarify also I think this is important point for anyone that's listening this is why these are tools that I mean that and this gets us to one of my sub headings in this rundown is boy plunger I told you I have a few quotes from Jesse Livermore because I think there's a great advantage right now in this market for people to understand how to use these tools and then my question really is also again sorry I have to interrupt you then go over the map but you're saying so many things that I don't want to miss out on I'm curious how you're able to apply this toolbox right because this is a very sophisticated level of risk management that you're talking about here and how you apply these tools and also how that toolbox might expand because I'm thinking right now you're talking about using options that I'm wondering you know how do you deal with margin calls in this environment and given just the liquidity and illiquidity and all that sort of stuff so that gets me to wondering like you've got a tremendous amount of knowledge and you're a very creative thinker you know I've listened to a few of your interviews and that has come across to me so I think someone like you I feel like you're in this market and you're probably able to stretch the boundaries of what you you're probably pushing up right up against what you can do in terms of all the different tools that are available and I really wonder how you see that toolbox maybe growing expanding and how that's factoring and sorry to kind of jump in there but I wanted to get that out there before I forgot yeah no problem so what we've been seeing for last year and I think is only gonna accelerate is professionalization of the space and many more tools coming online so six months ago if you wanted a short really the only way to do it was within an exchange so there were changes that gave you the ability to short that was very unattractive glad your ex well led Rex didn't even exist but like Bologna acts or BitFenix offered the ability short on their exchange the problem with that though was you have to post full collateral you're borrowing from that exchange those exchanges tend to be risky so they're not CFTC regulated the nature of facilitating margin means there's a risk of blow up of each change so some of them things like socializing losses right they tend to have flash crashes very frequently because there's people who can get margin called on those exchanges and because they're generally relatively unregulated and relatively opaque it'd be really really tough for an investor to say I trust them with 50 million dollars right so it might be fine for a retail investor say okay I'll put 10 grand on there i but how do you trust him with a huge sum of money so six months ago for the professional investor of the space I'd say shorting was almost impossible it was very hard to do approvingly now he things like Bitcoin futures shorting much much which is cash settled and that's very different than we're talking about here correct I'm curious sort of if you can tell me as we move forward how you might be able to use those what are the correlations between those markets and are they at risk of breaking down in a way that we wouldn't be able to foresee given how I knew the market is surely a ton of great questions there so first on the toolkit so letter X I think of as somewhere between there's CFTC regulated very professionally run but they don't have a huge balance sheet they're entirely a bitcoin business they're one of the biggest hacking targets in the world because they're sitting on Bitcoin and so there is a concern in my head that let's say I buy those calls and at the moment I only have a million dollars of risk right so I buy a million dollars in premium I can't get margin call because I own calls right someone who's short an option get margin called for me the most I can lose is that million dollars but let's say that million dollar bet becomes a 5 million 10 million 20 million dollar in the money bet well then I have that exposure to ledger X ledger X owes me that money that's a lot of counterparty exposure so what happens if ledger X gets hacked so they're regulated but they're not going to my knowledge so that is a concern that is a reason that would prevent me from wanting to buy it you know put a huge amount of collateral there and this is not a crystal of directs I think they're very professionally run you have other things arising like cash lending so now if I want to go short something for example there's an OTC desk Genisys that is a their big trading desk in the crypto world they have a large balance sheet and and they now will actually lend me what air quotes physical cryptocurrency so what that means is if I want to short Bitcoin I can go to the Genesis desk I can say I want to borrow 20 million dollars in Bitcoin they will transfer me the actual Bitcoin I can then short that Bitcoin by short I could just sell it I then get cash the cash goes in my bank account and I can't get margin called on that so Genesis can margin call me but they don't have my cash or my Bitcoin and so nothing kind of malicious or unsurprised or there can't be any any surprises I can't get margin call due to some weird market activity so that's a much more attractive way for me to short now and that only arose basically two months ago I knew a creative guy REI I listened to a few year interviews before I'm very satisfied so far so let's continue with that question I had about the futures market and their correlations yeah what do you think about that again I'm very interested in your so also listening to you talk it makes me it stresses me out a little bit thinking about your position like you know being in your position I'm curious I mean every fund manager has experience of stress but stress is a requirement for success I'm curious how this experience right now is for you being a pioneer in the space and you know talking to your friends who would trade in traditional markets right now or who are managers of other funds how does that differ and sort of what does this feel like for you interesting question it's not a CNBC question yeah so I'd say this launching block tower which I did with my co-founder Matthew gets and we left our jobs in July it was an extremely fast hedge fund launch we're working 18-hour days in parallel to launch August 15th so six weeks we launched the fund we've now grown eight people we're hiring eight more in the next two months we're at the weird intersection of a growth company and a traditional financial firm so we want to be best in practice in every regard in terms of being you know attention to detail matters so regulatory compliant legal compliance having operations that are tight security is paramount we obsess over security and yet we're also a growth company so we're trying to hire extremely quickly we're trying to grow we're trying to be industry leaders in the space and I'd say that intersection what's been interesting to me is I wasn't naive about the challenges of running a hedge fund coming from you Chicago you Chicago invests in hundreds of investment firms and I've underwritten some of them myself so I was pretty familiar with the space still I was amazed at how much operational work there is so we were to a point in our growth about six weeks ago where we had a team of seven and five of those people were on the operation side and only two on the investment side we're kind of incredible you think a seven person team is a hedge fund only two are investors but that's how much operational work there is so dealing with investor relations regulatory compliance all of that so now we're beefing up both sides of the organization how does that compare if you were if you were a traditional fund so it's more balanced it really really depends on the type I'll give an example so my former employer sus plan or national group there was a point where they had 200 traders and they had 900 other staff members so the other staff was everything from HR it was a lot of algorithmic programmers electrical engineers who would do things like produce the trading infrastructure that the traders would use but the people actually making the trading decisions were only about 15 20 percent of the firm that's how much kind of support staff you needed and is calling them support staff is maybe unfair because their critical part the organization one reason we're so heavy on the operational staff is just the speed so there's some things you only have to do once you only have to create a ppm a private placement memorandum once you only deal with the lawyers on that once we were fundraising from a great number of partners and onboarding each one again that's not something we're not gonna be continuing at that pace we were kind of racing to get up and running with that said they're you know it's a operationally intensive business so when you ask about about kind of how has it been for me and stress and things I stress out for sure about the portfolio about risks in both directions it's kind of funny so there's obviously the risk of capital loss but there's also the risk of underperforming email on the upside so we hold a lot of cash we obsess over risk and so what about when the entire market is going parabolic well that's also stressful right and that brings us to the benchmark the fact that you have all these different benchmarks that you're really up against yeah which is really interesting you put yourself in career pickle but it's also stressful dealing with being an entrepreneur right growing a firm dealing with hiring usable and all the aspects that come with just you know growing a business it's super impressive man what you're doing is super impressive and exciting and you're really sort of at the vanguard of something bring you and you get to learn a tremendous amount but putting yourself at the deep end of the pool like this counterparty risk exchange risk a very unusual set of risk factors for you guys that other funds don't have to deal with I mean the fact that you do have to worry about having the exchange being hacked on which you currently have open positions or whatever else do you put a lot of your your there's a lot of the crypt of the you own personally is that it's cold storage how do you guys manage that how do you basically mitigate the unusual risk characteristics of this market yes so anyone who's not actively trading none of your cryptocurrency should be on exchange what I highly recommend everyone is by a Hardware wallet so for example the Nano ledger or the treasure they look like USB sticks and they are industry best practice to store cryptocurrency and they're quite secure because we're active traders we need to have some cryptocurrency on exchanges so that we can react quickly we very consciously underwrite the individual exchanges and counterparties we're very conscious about the risk we're taking so at any given time we typically have about 20% of our fund fit more like 15% actually on exchanges and that's spread out over six exchanges and there's some exchanges we won't trade on because we don't think I mean ultimately it never makes sense to look at risk in isolation it's always a risk versus return so for example if you tell me that there's an exchange that's 50/50 to go on during the next year I might still put some money on it if I'm confident that the returns are worth putting 2% of my capital at risk so it's not that things are too risky or not or not risky it's always we're underwriting the risks traders so I say okay this is an exchange where we're gonna in ton of money for our LPS we're willing to risk 3% of AUM and have that sitting on the exchange and we think by having it sitting there if there's a flash crash if the market is moving really quickly there's an opportunity we can exploit mm-hmm so that's interesting you said how many exchanges do you trade on about six actively so how important is arbitrage for you because there are large significant discrepancies between exchanges particularly in some of these Asian markets where people are having a hard time getting their money out how are you capitalizing on those are you are you able to sort of so we don't were not focused on arbitrage my view on that was I don't want us to build a business where someone like a citadel or rentec these giant financial firms that are optimized for that if and when they get into the crypto game they could be better than us at that the next day that's Mars I don't want to build a business where we're competing against the world's best in their game right let's press on now with that said we have been doing some arbitrage because hey if it's low-hanging fruit and it's there and I can exploit it and I have money sitting on exchanges already why not so in December there was some great opportunities we did take advantage of them that's not a court business for us it's very small percentage of what we do and it's specifically because I don't I can't tell you that I'm better at that than everyone else in the world so what is where do you have a competitive advantage I think at the intersection between crypto fundamental understanding trading expertise and relationships it's like a triangle can you define crypto fundamental understandings I just mean generally a broad understanding and depth in understanding cryptocurrency the technology and the sort of ecosystem this is probably easiest with an example so I am non-technical I'm not an engineer I'm not a photographer I don't claim if someone was in the room and they said they're a cryptocurrency expert they probably know more than I do what I try to do is I don't think you've been through enough crypto meetups in New York City maybe not but um so I claim really no cryptocurrency expertise what we do is we talk to the world's best we talk to the best block exchangers the best developers and I mean my that as we're talking to the creators of the cryptocurrencies the lead developers of the project and when they disagree with one another I'm not making a bet so so if two of the world's best blockchain engineers disagree on a database architecture Who am I to decide between them but often what happens is all of the developers all the engineers will tell you one thing and the market says something else and that's because this is 95% retail market where people have no idea what they're buying so if all the engineers tell me for example that aetherium ether which is one of the leading cryptocurrencies is nearing capacity that it's about to be clogged as a network they all tell me that there's no special insight there but the market has no idea I can see the average retail trader the average investor is totally unaware of this that might present an opportunity for us to make a bet because then we have enough of a fundamental understanding what's going on and we know how to think like traders so I can structure a trade let me give us a very specific example of one of our best trades in around November 17th there was supposed to be a Bitcoin heart fork it was called Segway 2x it was very contentious it was very complex basically it meant that Bitcoin was going to fork into two and they're gonna be two chains that were competing this would've been a second Bitcoin fork yes so the earlier one was on August first Bitcoin cash Bitcoin cash was kind of like a spinoff it was friendly he was called Bitcoin cash not Bitcoin that's important exchanges gave it a different ticker symbol it had a technological protection in it called replay protection that meant that users he didn't know anything weren't going to lose money between the two chains and so for all those reasons it acted like a dividend so if you owned a Bitcoin before the fork after the fork you actually made money because you know a very nice dividend Bitcoin and acted as a dividend and it wasn't value destroying because the two chains didn't really attack each other the Segway 2x chain would have been a contentious hard fork where the two chains would have basically been at war heading into that if it happened it would have been the single biggest event in cryptocurrency history would have been the biggest event for Bitcoin I think it would've been incredibly destructive for Bitcoin not everyone agree with me on that but that was you explain your thinking sure so there's maybe three points of competition here one is you take an existing network and you split it into two generally the value of network effects is more than linear so if you double the size of a network it's more than twice as valuable if you cut a network in half it's less than half as valuable with Bitcoin cash that wasn't the case because Bitcoin cash and Bitcoin were truly differentiated in their value proposition it was a little bit like sometimes a company will split in two but they're different business lines so there aren't really you know it was a conglomerate of kind of a mishmash because bitcoin cash was sorry to drop just for the audience that may not know is the reason because bitcoin cash was attempting to solve the problem scalability in transactions and so it was more of a transactional currency whereas Bitcoin the original actually was if you wanted the store value it was it was more for that exactly so bitcoin cash was trying to optimize for transaction throughput for low cost high throughput transactions and Bitcoin was trying to optimize for decentralization and security and support the store value use case the communities were also kind of at each other's throats within the Bitcoin community before that hard fork you kind of had two camps that were fighting so by separating those two you could argue it kind of became you know more valuable networks more consistent in their vision with seg with 2x the 2x hard fork was a very very minor change in a literal sense it only doubled the block size whereas Bitcoin cash basically increased at more than 8x so the 2x would have been a relatively minor change wasn't really a differentiated value proposition it would have been competing for the brand and that's huge because imagine if there's an exchange in the US and another exchange in u.s. and Bitcoin what would is called Bitcoin and we gets the ticker symbol B to C m1 is a different product than what gets that symbol on the other the confusion that would have created would have been tremendous it would have led to probably very large loss of funds and a loss of confidence if you have a retail investor right someone goes home to Thanksgiving they tell their uncle hey you should buy Bitcoin and that individual just bought Bitcoin well maybe I bought Bitcoin for $5,000 and you bought Bitcoin for 2000 because it's literally a different thing and most of the people don't everything we just discussed very few people even up the people who owned Bitcoin they don't understand this they don't know this many people would've gotten confused and then there's also this technical issue of a replay attack where people could actually lose money due to malicious attacks that would have been possible between these two chains so I think it had been very disruptive so something that we did as an investment firm is we spend a lot of time heading into that talking to all the key players so I was a poker player at a professional level in college and I like as a trader I was kind of trained to think of trading as a poker game so who are the key players what cards do they hold what do they think is in practice what this meant was talking to coinbase and Zappo and bitpay and BIC oh and and Chinese mining pools the key players in the Bitcoin ecosystem to understand what is their positioning do they have a lot of Bitcoin Bitcoin cash how are they positioned as a business what do they think will happen what do they want to happen and how will they react to different scenarios so we gathered all the information and frankly we didn't have a clear view on what was likely to happen when segue to X was called off about a week before it was intended to go live suddenly everything kind of clicked for me and we put on a trade where we bought Bitcoin cash and Bitcoin cash is kind of a tangent so this was Bitcoin cash heart forked and was born on August 1st this hard fork was Bitcoin separating it to Bitcoin and Bitcoin to X sure so why would I buy Bitcoin cash and the reason is a lot of the Bitcoin community who favored larger blocks who favored high throughput low fee transactions were betting on Sega 2x they were saying okay Bitcoin cash we don't really know her care we're waiting for Segway to X so the moment Segway to X was called off I thought that entire camp is now going to shift to favoring psycho in cash and sure enough that's what happened in Bitcoin cash went up 5x over the next two weeks so that trade what was our edge how do I even describe it well I think you know we needed a decent fundamental understanding of the heart Forks themselves but it's not like I had a better understanding of that then you know I'm sure you can find hundreds of engineers who knew it as well as I did or better but it was also this understanding of the game theory it's putting the time in to develop the relationships and and meet the players and talk to them and then how do you construct a trade how's the you know understanding market psychology understanding how markets work when you look out into the world where other people see sort of binary outcomes it seems to me that you see a probabilistic function yeah I certainly try to well it certainly sounds I mean more like it I've been obviously that's but yeah go ahead yeah I credit my first employer or first employer after college the Squa International Group so it was a firm that was founded by poker players I played a lot of Poker in college obviously as a poker player you have to think probabilistically you're always thinking it people often think that odds play a bigger role in poker than they do they're just kind of an entry point like like any reasonably smart person could learn all the odds you need to know to play a decent game of poker in about an hour it's very simple but you learn to think probabilistically right because you're always waiting on that next card you're always trying to think what are my pot odds what are the odds I get that that flush on the river so you think probabilistically you know the futures uncertain you know that no matter how good you are you're very likely to lose a hand against a bad player it's you know the best player doesn't even necessarily win any more hands against the bad player they maximize their wins they minimize their losses so I thought probably from poker as a trader I was trained very very much to think probabilistic ly and I think it's especially important in cryptocurrency because the assets are so hyper volatile right we're talking about assets that can easily rally for X in a month I mean Bitcoin was eight hundred dollars last November it's now it now just crashed down to ten thousand right what a ridiculous statement where's $800 it crashed down to ten thousand so you have to think probabilistically in this market if you just say oh I think the coin is eventually going to conquer the world certainly as someone's managing other people's money that's not a great way to view things because on the path on the path from ten cents to ten thousand dollars bitcoins crashed 80 percent five separate times which also kind of brings us to something that I do want to touch on at some point which is how do you think about because you know a retracement or a consolidation this market looks very different than it does in a traditional equity market and that you know I wonder you know in changing market conditions how you incorporate that and I'm interrupting you in this one thing one thing I want to ask you though before we move into anything else or before you answer that question because it I just remembered it I'm curious your process like when you're sitting around thinking through a dilemma or problem this is a perfect example right said with 2x I mean you're trying to find sort of the play here the position what is you know how do you want to position yourself what's the opportunity I'm curious besides the the modeling what you did when you said it all just came together and you said it's you know the play is Bitcoin cash I'm curious how you experience that all coming together and what that process was because that's I think what you know is so exciting about what you're doing and the business that you're in is you get to have those moments and you get to play on the edge there yeah I'll kind of extrapolate this to like a life philosophy of mine so I think a good approach to life is most of the time you want to be relatively conservative you grind you put in the work you learn you study you gain the skills and then every once in a while if fat pitch lines up and by once in a while I mean once a decade maybe it's once a lifetime it depends on the scale we're talking and then you swing for the fences and then and then you have to be willing to take risk you have to be in poker you have to be willing to shove your chips and you have to be willing to go all-in in life that means maybe leaving your job and joining a start-up is a traitor it means maybe that's the time and you make the big bet and so that was true for me career-wise in terms of building skills you know following a relatively conservative path when I wasn't super clear on kind of what the right choice was and then it was leaving to launch a crypto fund as quickly as we can throwing all of my own money in it throwing you know all the career risk in it and similarly that's how I think about the portfolio so because we're positioned in a more risk-averse way all in for us is not all in in terms of 100% of the money into a trade so in this example I really like the trade I thought it was a home run we put 15% of the portfolio in it so Olien does not necessarily mean you know a crazy bet but it's a good chunk but it's a good chunk and it was a very very risky trade with a somewhat binary outcome so Bitcoin cash basically a very small number of people owned it and we're promoting it and if they had abandoned it I thought it could basically pet toward zero very quickly so it was it was something of a binary outcome very few things are really binary outcomes but I think that structure you use less data to go off of – I mean there's less you know there's more of a your gut is playing a bigger role in this market I mean that's my instinct and that's why I keep going back these qualitative questions right these are very you know I didn't even plan to ask you these they're just coming up as I'm sitting here against across another human being who's in a position to make millions of dollars off trades in a very short period of time given the volatile in this market and you have to make this very adult decisions and you have to put on your big-boy pants and do it and I just think you know it's an interesting thing that keeps popping back into my head how do you do that especially given the fact that you don't have this giant road map to go off of you know it's funny I get asked a lot how do you basically how do you invest in cryptocurrency without historical data and to me it's a really weird question because when I was at the endowment in Chicago I got shown a lot of back tests in finance everyone obsesses over analyzing historical data partly because it's there because you can so if you're grad student trying to get a PhD in econ the easiest thing to do is you do some slightly marginal analysis looking or the same analysis one else did on a new data set and it's cuz you can't you can spend three years doing that you can calculate something out the three decimal points the reality is that may or may not have any value in predicting the future so does the fact that will be good I mean the biggest mistake investors make tends to be extrapolating the past so in the 60s everyone said oh IBM is growing at 25 percent a year we can come up with fun metal argument White's best company the world will keep doing that and towards the end if you would extrapolate of that another 15 years IBM would have been worth more than every other company on the planet you get these very clear absurd outcomes that that seems somewhat rational there's extrapolations of the past we can calculate with the US equity risk premia so we can say okay over 100 the US has averaged whatever six and a half percent excess returns and let's say you've calculated in your modeling says six point six and minuses six point four like my argument is that doesn't matter at all that margin of error that point two percent is so tiny relative to the forward-looking error relative to the real question we need to ask is okay we have a rough idea what the path looked like what is gonna be different about the future and does that difference make us wanna double our estimate cut it in half you know so encrypt a currency it's that but much more extreme which is to say the biggest question I'm constantly asking is what will the next regime look like what fundamentally is changing about cryptocurrency that will make the future not resemble the past at all so you're talking about market regime I want to get into that it's interesting also what you're bringing up you're touching on portfolio theory and it's actually something that came up in my last conversation with Chris Byrne iski and you know Chris and you know Joel maneger oh they're fantastic and the super smart guys and but one of the things I did question Chris on was how much does he depend on because he uses a lot of portfolio theory I mean there's that's kind of in his book a lot and that is of course looking at the past and sort of building building on the future and sort of thinking statistically and that sort of a sense in a bell distribution kind of a Gaussian way so that's interesting that you say that you make a really good point on that so you're talking about changing market regimes talk to me a little bit more about why you brought that up sure it's at the center of how I think about cryptocurrency and and frankly how I think about investing in general even in the non cryptocurrency assets the difference is that a regime change in say US equities might happen once every decade or 20 years depends on regime is a very wishy-washy word it can refer to a lot of things but for example we had a 30-year bond bull market so if you were waiting for the next bond regime it's literally your entire career might have gone by in one regime so we have a generation of investors and traders who've never seen a bond bear market what does real estate do what do correlations look like how do commodities do in a bond bear market like we can look at what they did 40 years ago but obviously it's a different world economy now right like trying to draw a lesson from how copper and and real estate interacted forty years ago we might learn the wrong lessons right I mean even the construction of real estate might use way more or less copper than into 40 years ago so encrypt a currency it's the same idea just instead of a 40 year time frame you have like a three month time frame it's incredible how fast so you mentioned kind of a toolkit right so now you've seen me in CPU futures how's that gonna change market microstructure how's it gonna change the volatility is gonna make things more or less volatile these are questions that I think are more important than analyzing what a standard deviation of Bitcoin was three years ago hmm and on that one by the way I guess that since I raised the question I should try to answer it I don't think it's really clear-cut my guess is the way the futures and derivatives on Bitcoin I think the effect they're gonna have is they're gonna mute very short-term volatility you're gonna more market makers deeper order books people who soak up some of that very short term extreme so without market makers what happens is one person wants to buy 30 million dollars of Bitcoin and they sweep it up five percent or ten percent with market makers that 50 million dollar order doesn't move things so you get less very short-term volatility but the month-to-month volatility I don't think falls at all because that's fundamentally driven now also with guys like you entering the space in general there's more money coming in the ecology is changing and up until now this market has been closed off it's been very siloed right but you're beginning to get leakage into it from the broader market and that's gonna lead to some level of correlation so then that's kind of another way of getting into asking you what your broader perspective is on markets more broadly and let's kind of zoom out here and then also how do you think there's that impact market movements in Bitcoin like what would be the impact of let's say a breakout an inflation or a deflationary spiral in the economy or a recession how would all those things impact the cryptocurrency space and how do you think about all that yes so at the end of the day the price of an asset is driven by supplying demand stupidly simple statement right but order flow which broadly just means who's buying who's selling is so critical to understand asset prices so and this is true in every level so if you asked me where will US equities be in a decade I think I would care less about macro things like how much did the US GDP grow what our profit margin accompanies I think if I could only ask one question my question would probably be something like what is the savings rate or what percentage of people's income are they putting into retirement accounts because that tells you how much money is flowing in passively how much money is going into 401k so you have all these people who they're not looking at p/e ratios they're saying okay I'm gonna put 5% of my monthly income into my 401k and I'm gonna passively buy the sp500 and that so dramatically impacts the price to earnings ratios of stocks in cryptocurrencies even more extreme because there is no quantifiable straightforward intrinsic value so Kris Pearn iski has done phenomenal work pushing us towards some kind of quantification but he's very practical and reasonable about this what he's providing us with is is a model and mental framework he puts precise numbers to it but he's saying smart enough his understatement he fully understands that it's kind of garbage in garbage out that he's just providing a mental framework and the numbers are somewhat arbitrary right I'm just throwing a dart of the map and we're starting somewhere so we I spend a lot of time thinking about questions like here's a really simple example so six months ago now 12 months ago South Korea and Japan were a relatively small part of the cryptocurrency market if you looked at both real buying and exchange volume it was basically us in China China now is something like 5% of the market in terms of exchange volume it's more than that I think in terms of buying power it's a large percentage of Bitcoin hash power but Chinese become a much smaller piece South Korea and Japan are huge South Korea is about a third of the global cryptocurrency market now in all regards how's interesting and there's a huge opportunity there for when I was talking about arbitrage that's a huge arbitrage opportunity there but go ahead yeah so I'll answer the neglected answer arbitrage question so the Korean arbitrage basically no one can do at scale so individual Koreans can pull 50 thousand dollars a year out and Wan the way it often works as someone with the family member was a business there which maybe is some kind of export license they can pull a little more out so there was a point where you could have traded a billion dollars of Bitcoin at a forty percent premium you could have made 400 million dollars if you had the ability to get Korean Won out of Korea no one was able to do it to my knowledge so what are the sorts of arbitrage is you can do in Korea right now so they're arbitrage you can do in Korea so you can do for example it's called triangle arbitrage so for example I could transfer Bitcoin to a Korean exchange converted into ether bring the ether back to the US and convert that back in a Bitcoin so if the Bitcoin ether pairs spread is different in Korea versus the US I can arbitrage it what I can't do is arbitrage via I can't arbitrage Korean wan versus US dollar prices okay so back to the macro perspective and sort of the broader economy that sort of gets into this question of when are we going to see a change in market regime the market has up until I mean we had 2008 to 2012 – Mario Draghi speech we pretty much had this inflation deflation after that the markets pretty much said okay the Fed is the only game in town central banks within game in town lever up as long as rates are low rates have been rising and now the question is what's gonna happen there are those who think that we're gonna tip back into deflation that the economy won't be able to you know sort of get out of this liquidity trap that we've been stuck in that were in the road of Japan I've heard you take the opposite view that you think there's actually an unrecognized level of risk that there will be inflation and I think in that sense you sort of share much in common with Christopher Cole who've had on the show before how would you respond to that and how does that affect your trading right now yes the first let me say almost no one has good a global macro in trishal markets there's almost no one in the world with a decent hit rate in fact there's no one in the world who's more than 70 percent on calling in straight direction so the world's best bond traders their world's best interest rate traders they will readily admit that they're maybe a little better than a coin flip at calling which way interest rates or know which way inflation is gonna go it's incredibly hard so I anything I say in that regard is very off ur humbly but that was one of the reasons I got into cryptocurrency so 2008 crisis hit the US Federal Reserve started printing insane amounts of money so the base money supply increased 4x the amount of US dollars circulating increased fourfold and the reason that didn't produce big inflation was cuz the velocity money fell and lending rates by banks fell and borrowing demand by companies fell but my thinking in 2009 was I know this I'm a soon of economic history and I know this is not going to nearly produce inflation the deflationary impact of 2008 is gigantic we also things like automation that are deflationary in nature they put downward pressure on wages demographics some demographics so I knew that there was gonna be inflation anytime soon but I'm like ok at some point this massive money printing that isn't just the u.s. it's the world is gonna make me not want to and Fiat I'm not gonna win of US dollars or euros or yen and what do I want to own that can't be depreciated that can't be printed into oblivion so that kind of set me on searching for something like a Bitcoin that is supply constraint this is 2008 you were concerned about inflation at the time yeah I really was 2009 I started thinking about it but I knew that I had time I knew I didn't call for inflation 2000 I in fact the opposite I said like there were people at the time saying the Fed just quadruple the money supply you know most definitely so I'm smart enough to know that we had at least a couple years can I ask you something about that re because I remember that time very well and there were many people that were convinced we were gonna have inflation what in your sort of personal education gave you the conviction that we were going to have deflation so to think we were gonna have inflation you need a really simplistic economic model of basically money gets printed and that causes prices to go up if you look at any kind of historical money printing episode in history there's so many historical examples where a central bank printed tons of money Japan is the classical and one failed to get inflation and so if you just dive a little bit into why and you then see the importance of bank lending demand for in fact a huge part of inflation is demand driven so the fact that banks are showering money on people it's almost never enough the fact that central banks are printing money is almost never enough to cause inflation you need leaders to demand higher wages and to be able to demand it and you need businesses to be borrowing you needed a penny more yeah you need the banking system to be able to create multiples above that base money but go ahead I just wanted to ask you about that yeah yeah so I knew we had time but I was starting to kind of look for anything for it there's a really important distinction to be made here that there's no like good academic way of distinguishing so people say inflation or they say currency depreciation and if I say currency depreciation that implies versus something so if I say the US dollars gonna depreciate the next question you should ask me is against what against do you mean the euros gonna go up do you mean the yen's gonna go up and I actually say my call starting in 2010 which was this will not happen yet but at some point probably in a year or two or three it was there's going to be massive massive currency depreciation not against anything any other currency so what does that mean it meant that I thought that the US dollar and the euro and the yen we're all going to depreciate relative to real assets so relative to real estate and commodities and I think we've seen that so the the kind of bubble air quotes in basically everything is rallying right stocks real estate commodities and you look at Treasury bonds right so in the u.s. we have somewhat reasonable interest rates but much of Europe has zero or negative interest rates right you think about the absurdity of like someone is paying the government of Germany to borrow their money for five or ten years I'm paying you to take my money it's absurd to me that you have financial experts and heads of banks calling Bitcoin a bubble and not hauling paying someone to borrow to take your money a bubble like that is such a clear photo what you're saying a bubble here is the Fiat system is a bubble based on what you're saying yes so what we've seen is and I think that is the current this massive currency depreciation that I think is going to celery so what does that mean so we're now at this weird point where people don't want to feel but stocks look pretty rich real estate looks pretty rich so what can rally without looking absurdly overpriced relative to currency so I can tell you like right now I still like cryptocurrency I like gold it's kind of another bet on that do you have a target for two thousand do you think that we might see that in the next year Oh an old yeah I don't have an exact price timing these things so slightly broader the u.s. is under attack as global reserve currency I think it's very likely to lose that status this tent currencies being knocked off her pedestal tends to take far longer than people expect so you have really really clearly unsustainable paradigms whether it's like the Bank of England when Soros broke the bank people were calling for that five ten years but ten sap and currencies is there's a really clear dynamic everyone knows a pecks gonna get broken traders give up on it they try to make that bet one you're after another and eventually they give up and then it does having ten years online so I'm wary of trying to pick a time there are a lot of people like you look at one of the reasons I'm bullish on gold right now is that for five years people been bullish on gold for the same reasons I'm bullish right now and they've almost given up so the sentiment is people which like they've called you you know getting back this sort of notion of ecology a lot of alpha driven investors have also gotten really they've sort of died out of this ecosystem because they were you know the beta has done so well the market has done so well and if you've chased alpha you've had a really hard time so that mean that makes sense what you're saying also by the way we had Robert Johnson on the show you mentioned Soros in the trade we talked about that trade we talked about the the breaking the Bank of England so let's say we have a recession you're saying that in the midst of a recession you don't expect to see a negative knock-on effect on asset prices I think it'll depend entirely on whether it's an inflationary or deflationary recession so most recessions are deflationary I don't know like I'll thought my Hetal say 80% um I actually don't I'm making up that no but certainly the vast majority for a good reason it's not that easy to have an inflationary recession and I could see either happening in a deflationary recession where the recession is basically a global slowdown in growth general wealth destruction which could be caused by a lot of things could be caused by war political turmoil just a general cyclical type recession I expect all asset prices to be hurt so I would expect cryptocurrency to be hurt at the margin now the thing to understand cryptocurrency is the idiosyncratic vault is so gigantic for example like ceteris paribus all things being equal let's say we think that due to money flows cryptocurrency will 2x and 2018 if you then tell me there's gonna be a recession then maybe I say it only goes up 20 percent so I'm not saying that it goes down because that correlation is pretty low but all things being equal I think if equities are down probably cryptocurrency goes down that relationship is very likely to strengthen over time so two years ago the people who own cryptocurrency it was a facebook engineer who looked at the price once a day who had maybe a couple hundred grand in Bitcoin and who had a day job and that wasn't a huge part of their portfolio most likely and so they weren't rebalancing they weren't saying oh my bitcoins up I'm gonna sell someone other buy equities it was just kind of a hobby it was a thing on the side as more institutional money flows in a cryptocurrency you're gonna see what you started to see so before call 2004 commodities were not really part of portfolios for the most part if they were it was more in the equity sense so so people would own a stake in a gold mining company they were a mistake in a natural gas driller what happened 2004 to 2006 was the suddenly commodities passive exposure to the actual physical commodity became kind of okay Devon a portfolio so you had ATF's yeah see what ETFs like USO and ung that became gigantic pensions started passively owning crude oil and that changed the market dynamic it changed the correlation because suddenly if a pension has 5% of portfolio in crude oil and 95% in things that are highly correlated equities then what happens is when the 95 percent Falls they then rebalance so that causes them to sell crude oil and their their price insensitive sellers they're not selling phono reasons they just push the price down because other stuff went down call it a wealth effect or a rebalancing effect so we don't see that that much yet in cryptocurrency I think we will increasingly as crypto becomes part of institutional portfolios mm-hmm you know I could get gout with you on the macro stuff all day but in the interests of time I want to ask you more specifically what sort of plays you think are most interesting this space right now are there things that you can share that you're looking at and there are any things that sort of someone who's obviously not invested in the fund doesn't have a professional money manager managing their their money that they would look to do and not just generally but also specifically in the crypto space so my advice on this is pretty similar to when I used to have relative about trading say equity options which was my first role susquehanna you don't want to compete against professionals at their own game so I in my own portfolio I don't buy individual equities because it's a full-time job so there are people who were role class at it who spend 80 hours a week doing nothing but stock picking why do I think I can beat them as a hobbyist right and that's that's something I do have some expertise in right so why would someone want to play against me picking individual crap or actively trading cryptocurrencies right it's not say they can't make money but it's just not an attractive game to be in it's not that I'm smarter than them but if you're a surgeon you're a brilliant surgeon you're doing surgery 60 hours a week like okay well maybe you could be better than you at this but you're not doing it full-time there's a lot of pitfalls there's a lot of easy ways to lose a lot of money whether it's exchange counterparty risk security failures where you have your coin stolen because you store them improperly losers yunge outright scams so a huge number of people right now are losing money a lot of them don't know they've lost it yet but it's lost buying into worthless I SEOs initial point offerings I say they don't know it's lost because either that ICO has not become exchange-listed yet so there is no market price or there's a market price but there's no liquidity it's totally crazy do you think it's not mean to me this is a mania unlike anything I've seen this isn't comparable to the late 90s where you actually had companies that had products and actually had revenue here you don't even have in many cases you don't even have a product demo you have a piece of paper with some ideas on it and maybe some math if you're lucky and you have people being able to raise billions of dollars from the market what accounts for that how much of that do you think is also a reflection of the forces we were describing before the low interest rates then the high levels of income inequality not income wealth particularly wealth inequality and the fact that this offers the first opportunity for a whole generation of people to get exposure to that lottery ticket yeah I think that last part is really critical so part of this is a result of regulation that precludes individuals who were not accredited investors from participating in venture capital and so if you're that individual it's like well the US government is not allowing you access to something that could give you a 10x return it you literally are not allowed to participate in attractive investments so it should go that way and so this may look attractive to you another thing like I think a lot of this comes down to really basic human psychology so the ICL market is gonna have nine lives I expect it to collapse and then be reborn and collapse and be reborn again the Reese is that it's incredibly attractive to get rich quick scheme for developers and it's incredibly attractive as a get-rich-quick scheme for investors because it is a lottery ticket and it's a lottery ticket that provides liquidity very very quickly so I think what's likely to happen is the regulator's are starting to crack down increasingly the current wave of I SEOs may sooner or later you'll have a crash you'll have a freeze and then it'll be reborn in a slightly different form so you're going to have actually correctly registered security offerings it may be offered on decentralized exchanges based in locales that support it so for example you may have development teams moving to wherever it is Cayman Islands or zoo Switzerland or you know wherever they feel safe doing it and then they'll be able to sell those tokens on decentralized or they'll become listed on decentralized exchanges it's not going to be easy to stamp this out and a lot of people are gonna lose money over the next I think three to five years you know before I read Kris Pearn is keys initially his paper on the equation of exchange and then his book and then having him on the program and also I was looking really to understand where I fell where did I really put Bitcoin as a value proposition that I see it that it had an upside opportunity that there was really something there and where did I rank aetherium and sort of these the utility layer or the utility protocol and then the the sort of the layer of DAPs I actually you know not to come out and say this I'm sure they make a definitive statement here but the one thing that I actually think people don't see it as risky enough is theorem I actually think they're really for me the one of the really great opportunities is identifying teams that are building decentralized applications that might be able to scale with a utility protocol that has not been invented yet or has not come out yet so I think you can get exposure to some of those if you know what you're doing I think bitcoin actually has a use case and there's a store of value of but I don't know how to price it as much as I've looked at it but I think aetherium for me is one of those things that people are under appreciating the risk that it will be replaced as a foundational utility protocol under what you think of all that yes okay so first let me say no one knows anything an amazing thing about cryptocurrency right now is when you're valuing companies whether the VC or traditional perspective there's at least a business there or prospective business and it's not winner-take-all we're not gonna end up with a world with one company right there is room even within an area like social networking you can have both a LinkedIn and Facebook and you can even have more niches and you can have second place in third place winners with cryptocurrency a big question is is to what degree is this gonna look like a winner-take-all world are there going to be a thousand valuable cryptocurrencies or ten is it going to follow a power-law is it going to these are questions that are fundamentally I think somewhat unknowable because there's a lot of individual pieces you have to solve for and some of those pieces here's an example is something that no one knows we don't know if there's a viable consensus mechanism a consensus system alternative to proof of work so etherium is looking to transition to proof of stake you have things like ripple that have distributed proof of stake you have proof of space-time which is a project by Bram Cohen creator of BitTorrent they're all experiments we honestly don't know and there are some really phenomenal debates between the world's best cryptographers and blockchain engineers new code is buggy there's no way to know a priori the new code will not be buggy and similarly there's no way to know the new consensus system will work will be sound from a game theory perspective until there's billions of dollars on the line now does that mean that you're on the lookout do you have people in the fund that are actively looking for that yes so a question that I asked pretty consistently is I like taking the base theorem approach if you ask what could kill Bitcoin and you ask a lot of smarts Bitcoin developers for example their interest nothing but these are some of the smartest people and they're great critical thinkers and so I kind of need to get that information from them so the way I framed it to them as well as to myself is let's play a game Bayes theorem let's say Bitcoin died what killed it and so my current answer I think is it's either a consensus mechanism that provides greater security and decentralization at less cost which we don't know if that exists but we can't say it doesn't it won't be invented or maybe it's been invented and just not proven yet and the other is governance mechanism so Bitcoin has something that I didn't invent the term but there's no formal term for it but a lot of people call governance by exit and the idea is that if you basically want to change Bitcoin you have to hard fork and leave the existing chain if you use proof of stake or you've you've hybrid systems like decried these as proof of stake and proof of work hybrid that allow for voting and the idea is that the community can be a supermajority vote majority vote you can set the rules however you want there's some way to change the existing code without requiring hard work we don't know if that's superior or not it's kind of an open experiment but it is fundamentally different it is truly differentiated so big picture let me take a slight step back I think of most cryptocurrencies are like seed stage VC investments their experiments most will fail as with any new company most new companies fail is the more ambitious they are the more likely they are to fail doesn't mean it's not a good investment doesn't means not a good experiment if I have a VC portfolio right and I xx I don't like the term lottery ticket because it implies you're just guessing but you know I make 20 bets on things that might kill Facebook if one of those is a winner I was a great investor mm-hmm most cryptocurrencies I think ether included our VC style investments if theorem is competing on features I think this is an important point a theorem will not survive without sharding if your aim will not survive without so sharding is a way to scale a block moves computations off chain aetherium ultimately will need to support decentralized applications and to do that it needs to work very differently than it works right now so aetherium in its current form will die everyone kind of knows and accepts that and the question is can aetherium basically pivot I'm not using the language the team would use a lot of people in crypto would object the language I'm using but my view is aetherium is a great team a great brand a great development community the question it's a little bit like uber eventually we're gonna have self-driving cars whether uber exists in ten years or not depends on can they pivot to that new industry and you can argue that they're in a great position to pivot and to remain a market leader and I would probably agree but if uber survives and ten years it's gonna look nothing like what it looks today I think aetherium is kind of in the same boat so that means aetherium is ripe for disruption it's very very easy for someone to produce a better aetherium that's better on all sorts of features that kills aetherium Bitcoin I think is the one exception in a cryptocurrency world I think it's not competing on features Bitcoin is competing on longevity stability and security network effect to network effect too but it's important to note that less than 1% of the world uses cryptocurrency so if Facebook launched Facebook coin in one day would have greater Network effects than Bitcoin has accumulated over a decade so let me kind of finish that thought cuz I think is important so the analogy here I would use is uber has to move fast and break things uber has to constantly innovate or will die Lloyd's of London doesn't so an ancient insurance company it can be priced over its peers it can have fewer features it can be less accessible it never worse UI it may win because it's competing mostly on the fact that it's 200 years old you know 100 years old or whatever same with a JP Morgan type JP Morgan is not really competing on features basically they can be behind all their competitors as long as it's not so so much same with coca-cola if someone comes out with an exact replica of coca-cola under different brand and it's five cents cheaper it's not gonna kill coke whose cokes not competing on price if someone comes up with coca-cola it's 90 percent cheaper well maybe that would do it so when I look at Bitcoin it's there's a line from navall rava cots who's CEO of Angelus a great thought leader in the space and he says all between needs to do to win a survive hmm I don't know if that's true but I think that's kind of the right mindset and so I asked what could kill Bitcoin not you know something with slightly lower fees isn't gonna do it something with 10x lower fees isn't gonna do it something with 10x the transaction capacity isn't gonna do it I think it's something if you can get the same security and decentralization with a hundred X throughput or 1/100 the costs that might do it well so I'm not clear if the throughputs really the issue here and that could brings us back to what chris has done when his work on velocity last question this feeds back into what could kill the etherium are you familiar with the hash craft protocol consensus yeah yeah I actually just did a bit of a dive into it what do you think of it so slightly more broadly it so it's an implementation of a directed acyclic graph and that's a technology it's been around for a while block chains are terrible at many many things they're incredibly inefficient they make no sense for anything like Internet of Things they make no sense for your coffee to talk to your microwave directed acyclic graphs are incredibly useful and efficient for some things it's funny blockchain has become almost a religious or political term it has all these connotations it's a database structure the end of the day it's a database structure and you can have a cryptocurrency that's based on many other database structures is the blockchain the best structure for a decentralized cryptocurrency I think there's some evidence it's currently the best we've ever seen to say that nothing better will ever come along it's kind of a weirdly religious statement as me same with directed acyclic graph it seems like it's far better than blockchains for certain use cases that have nothing to do with what we probably care most about what do you think about the actual consensus protocol to forget the fact that it's a dag yeah it's actual consensus protocol I've interviewed Lehmann Baird twice the I bring this up you know because we've actually covered this on the program I I put on a panel in New York in October I had leave it on September and so I've covered this and I've had the the team I had manse the CEO on the panel as well and it's a protocol that I found extremely impressive and extremely promising of course they need to scale it as a public ledger but I think there are very interesting ways to do that so I think it's really important to distinguish technologies from investments especially when we're dealing with the open source world so the engineers behind hash graph are brilliant there's no question that's not something I can even comment only so when I say they're brilliant that's not even me saying they're brilliant what I'm saying is other engineers in the space that I respected told me they're brilliant I can't talk to them and say whether they're more or less brilliant than Batali I'm not at that level right it'd be like maybe me judging which are the two best neurosurgeon in the world are actually the sure sure sure right so I can tell you there's consensus among engineers that it's a great team a brilliant team they've been very innovative they've invented new engineering new cryptography so here are the downsizes investments so it is there's a private company behind it that run it happens world and so there's a real question over really over the application in the use case so if we think how valuable can a database structure be and where does the value really come from so let me take the extreme example so what they have with hash graph is an extremely efficient database structure potentially for communicating information ultimately it's all information right transferring money is transferring information I can do that on one server so I can beat hash graph on throughput on myself like I can literally go home and beat hash graph on throughput by running on a centralized server same with any other project so I can beat ripple on throughput I can beat neo on throughput by running on one server so what is the value proposition here so basically there's a spectrum of decentralization mm-hmm any time you move away from one single server you're gonna lose some efficiency in some form right so at one end of the extreme you have Bitcoin which is on around 12,000 public nodes there's much more listening nodes incredibly inefficient architecture but what we get from that is of what we've seen of the database architecture is kind of the most secure the most transparent that exists right and then you have projects like ripple or neo that are somewhere on the spectrum so they're not fully centralized or not fully decentralized and it might be a really happy medium for a lot of use cases so the analogy I like using is insurance I don't need a billion dollars of insurance on my quarter million dollar house makes no sense there's there's no extra value for me paying that insurance premium similarly why do we pay two percent or more per credit card transaction it's not because it's hard to transmit the information you're paying for mostly insurance you're paying fraud protection is one of the biggest pieces oh I don't need fraud protection of buying coca-cola so what I'm saying is I think on that spectrum there a lot of use cases for which a semi centralized cryptocurrency makes tons and tons of sense however as you get really towards the centralized end you're then competing against Amazon Cloud Services and I'm skeptical that a technology is going to be very very valuable competing its Amazon Cloud so you need a to beat Amazon Cloud Servers you need it's a giant business and so they have pens they have some IP which a lot of you have a lot of currencies with zero IP their open source therefore Keable so when all there is is code and there's no network effects and people like this things worth a billion dollars my answer is why literally can just copy it and you have no network infection I've known ever effects so how was your thing worth a billion so it makes no sense to me so hash craft to me is I think that the challenge they're going to face is at some point it's okay it's a great technology but if someone can implement anything similar if they can get around the patents they can violate the patents that they can find a way to do something very similar that's a great point you know and the problem is that because it's centralized because it's owned by a company they're gonna be really smart about incentivizing developers to work also yeah I mean the second point is one that I've thought it before the first one I hadn't thought of I thought about it a bit in terms of China where you know there could be Chinese developers who would just let's say don't have any reason to sort of adhere to the patent I think that's a really interesting thing about violate but just from a technology standpoint and well and we'll leave it there just goes running so much I the time re is I am very excited to see how they try and scale it I think that it could offer a more amenable consensus protocol for things like proof of stake or an alternative ways of scaling a public ledger so just the sort of curious person in me is very interested and I think it's really just something that I've been watching and will continue to watch re this is freaking great I wish we had more time I really could have just talked to you for like another hour super smart you're super creative guy I wish you the best success with your fund and I appreciate you very much coming on the program thanks so much for having me and that was my episode with Ari Paul I want to thank Ari for being on my program today's episode was produced by me and edited by students and allowed for more episodes you can check out our website at hidden forces pod calm join the conversation through facebook twitter and instagram at hidden forces pod or send me an email @ DK at hidden forces pod calm thanks for listening we'll see you next week

4 thoughts on “Cryptocurrencies Trading Strategies | Risks and Opportunities with Crypto Fund Manager Ari Paul”

  1. Jesus Christ please learn to SHUT UP during the interview!! You kept interrupting him before he could finish answering. Just as he was getting to the interesting part of his options strategy, you cut him off FFS!! Great potential interview ruined due to your incompetence.

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