Why there's value in cryptocurrency?

Interview transcript of Ari Paul (Blocktower capital, CIO) by Sara Silverstein (Business Insider):

Sara: Why do you fundamentally believe that there is value in this cyrptocurrency world?

Ari: So there are quite a few use cases. I think the biggest and clearest, and easiest to understand, is as a store of value that can't be censored and is resistant to seizure. And so, the really clear example of demand for this, that I see, is the offshore banking system, which is roughly 20 trillion dollars today. And it's not just people trying to dodge taxes. Apple, Amazon, every billionaire on the planet has wealth stored there. And firms like JP Morgan collect fees to offshore law abiding citizens' wealth. And people want to store their wealth securely, in a way that no single judge could freeze all of their assets, right. Amazon doesn't want their entire global business operation to be shut down by one judge in Brussels. They want to be able to go through a lengthy appeals process and keep their business operating. So cryptocurrency performs same task of the offshore banking, of keeping wealth secure an order of magnitude better. So we see massive real fundamental demand for this use case. 

Sara: And what other financial assets make sense to be on a decentralized database or why would they?

Ari: Yes, there's a huge distinction between the money use case, store of value, and the blockchain use case, for other assets. And I think it's useful to kind of separate those. So a blockchain makes a ton of sense to record in real-time legal title. So I was a treasury bond trader, for example, and an example in finance, that anyone who's traded treasuries is familier with, is: failure to deliver. So Goldman Sachs will sell a bond to Credit Suisse, who borrows it from JP Morgan, and the same bond in a day, might trade across 12 banks. And if one back office fails, they fail to make delivery of that bond, you get what's called a cascading failure to deliver. Because no one knows who actually owns the bond. And that can take weeks to fix. So imagine if you just have a shared database, a database that each of those banks held, that was kept accurate in real time and that no one could maliciously change or manipulate. You would know who owns what bonds and you might be able to eliminate half of the existing back offices in big banks. So a massive cost savings. 

Sara: So you belive in the blockchain as having a value in the future for us? How does that translate into value for cryptocurrency? 

Ari: So, yeah. I think a really useful idea - a blockchain is just a type of database. It's a distributed ledger that in some use cases, like for a banking back office, is kind of like a database upgrade. So massive improvements in efficiency, but probably not that transformative or disruptive. When you take a blockchain and you make it public and decentralized, and then you add money to that - you add a cryptocurrency - then you're looking at something that is that first use case, that offshore banking system, that I think is fundamentally disruptive. And disruptive financially, economically, and even potentially politically. 

Sara: Do you see any institutional money in cryptocurrency right now, and is that going to be a huge level for these values to skyrocket? 

Ari: Absolutely, so we've seen this really clear path of adoption. The earliest adopters were engineers, self-described cypherpunks. Then you had a wave of kind of Silicon Valley tech elites, people who would have a successful exit, who had a high risk tolerance, and who liked taking risk on new technology. Then you had kind of an early wave of maybe people like myself with a little more of a Wall Street background, as well as high net worth individuals, who are a little bit risk-tolerant. What we're seeing right now is a shift from small family offices to big. Venture capital firms are basically all in. So most of the famous venture capital firms, not only have they been in the space for a few years, they're now directly investing in new cryptocurrencies. And of the 10 largest family offices in the U.S. at least seven of them own cryptocurrency. Maybe more, but seven I'm sure of. So the next wave is - in kind of the institutionalization of the space - is we're having the CME futures that are likely to launch next month. There's a huge number of entrants who want to invest in cryptocurrency, but can't. For security reasons, operational reasons, regulatory, but they can easily buy a future, that's on the CME. So that opens the door to groups like endowmments and pensions. So far, endowmments and pensions own zero cryptocurrency. You have an asset that has been the highest returning assest class over the last eight years and it's uncorrelated to everything else. And while there's certainly debate over the future prospects, it lines up as the holy grail for a portfolio. In the sense that, if you size it appropriately, if you size it small, the risks are idiosyncratic. It actually reduces the rist of a portfolio. So endowmments and pensions, as they get comfortable with the space, in all aspects regulatory, compliance, as well as underwriting investment risk. They're going to get it. And that's a massive wall of money coming in to a relatively small asset class. 

Sara: And what do you think the timeline is for that?

Ari: I think the first endowmment is probably going to write a check in the next few months, a small check. Endowments won't be in size for probably six months and not in size by - from their perpective for probably 12 months. Pensions are probably 18 months away and the key - the reason given those dates is having thirst-party custody, that is legal qualified custodian, is a huge hurdle particularly for pensions. You have issue like ERISA, that are actual fiduciary challenges. And having a third-party qualified custodian, for many crypto assets, is probably something like 12 months away, maybe 18 months away. 

Bitcoin may be a bubble

"Bitcoin is a bubble."
"Maybe Bitcoin is a kind of a bubble."
"A dangerous, speculative bubble."
That might actually be true. This is Bitcoin's multiple price rising over the past three years.


Eight other famous asset bubbles, three years before they peaked and burst.


Bitcoin is riding right up to perhaps the most famous bubble of all, the Tulip Mania. And to be fair, it does have all the signs big signs of a bubble. The rapid pace of movements, a whole lot of speculation without sufficient understanding of the risks and people who would not otherwise invest are looking to get their skin in the Bitcoin game. The CBOE, CME Group, Nasdaq are even planning to launch Bitcoin Futures. The same move the Dutch pulled just before the crash in the 1630s. For every asset bubble it is the same story, otherwise level headed people will drive prices for certain assets to unexplainable heights whether that is the price of Beanie Babies, stocks, houses or perhaps cryptocurrencies. Since its inception the price of Bitcoin has gone up 50 fold, if it were to maintain that same rate of growth, its market capitalization would eclipse the US economy in the few years from now, that is why some experts are saying that Bitcoin's rapid and accelerating price appreciation is unsustainable. What it comes down to is the rate of returns, for stocks that is the dividends, in real estates we are looking at the rent, with bonds that is coupons, but for Bitcoin there is actually zero intrinsic value. It generates no income aside from an expectation of a more price appreciation. So it is valuable because people think it is valuable. Even if you do not even buy the whole bubble narrative, the veteran trader Art Cashin says 'the technicals do not lie, Bitcoin has gone parabolic so that usually does not end well'. It is pretty hard to ignore the math, the velocity of move does indicate the Bitcoin's price has gone parabolic and well, parabole moves just don't last.