Hunter Horsley, cofounder and CEO of Bitwise Asset Management, and Matt Hougan, global head of research at Bitwise, describe their vision for Bitwise, its current funds and indices, as well as how it handles things like forks and airdrops. Then they give their reaction to and interpretation of the SEC disapproval of their Bitcoin ETF proposal, as well as what their focus will be now to try to get a Bitcoin ETF approved. We also discuss their general thesis around how the crypto space will develop, whether or not indices and funds around the top 100 assets will ever make sense, their ideas on how to value these networks and whether or not the company would ever try to compete in the DeFi space. Plus, don’t miss our conversation on Bitcoin IRAs.
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Episode links:
Bitwise: https://www.
Hunter Horsley: https://twitter.com/
Matt Hougan: https://twitter.com/
Unchained interview with Spencer Bogart: https://unchainedpodcast.com/
Bitwise 10 Private Fund fact sheet: https://static.
Bitwise 10 Offshore Index Fund: https://static.
Grayscale Bitcoin Investment Trust: https://grayscale.co/bitcoin-
Bitwise Ethereum Fund: https://static.
SEC order disapproving the Bitwise Bitcoin ETF proposal: https://www.sec.gov/rules/sro/
Matt on CNBC discussing the Bitcoin ETF proposal: https://twitter.com/CNBC/
Bitstamp/BitMEX trading manipulation: https://twitter.com/DoveyWan/
Jake Chervinsky’s tweet about how the SEC is unlikely to approve a Bitcoin ETF under Chair Jay Clayton: https://twitter.com/
Unchained interview with Jake: https://
SEC commissioner Hester Peirce’s dissent to the disapproval of the Winklevoss Bitcoin ETF: https://www.sec.gov/news/
Van Eck’s withdrawal of the Bitcoin ETF proposal: https://www.coindesk.com/
Chris Burniske on how to value these networks: https://
Transcript:
Laura Shin:
Hi, everyone. Welcome to Unchained, your no hype resource for all things crypto. I’m your host Laura Shin. Heads up, everyone. In case you missed it, a few weeks ago I rolled out a new feature on Unconfirmed. A weekly news recap. This summer through my survey you listeners said you’d be interested in a weekly news recap on the show. So now you can listen to my take on the top stories of the week after my guest interview at the end of every Unconfirmed. Go subscribe now to find out what I think are the top stories in crypto each week.
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Laura Shin:
My guests for today are Hunter Horsley, Co-founder and CEO of Bitwise Asset Management and Matt Hogan, Global Head of research. Welcome, Hunter and Matt.
Hunter Horsley:
Hey, Laura.
Matt Hougan:
Thanks for having us, Laura.
Laura Shin:
Disclosure. Bitwise has been a sponsor of my podcasts in the past. Let’s start with your backgrounds. Hunter, why don’t you go first?
Hunter Horsley:
Sure. So Bitwise got started in 2017. Prior to that, I was a product manager at Facebook. Before that at Instagram and before that at the Wharton School. I think like many people in San Francisco in 2017, sooner or later, someone says to you, hey, do you remember that Bitcoin thing. I’m not an OG crypto person. I’m 2017 vintage, but I had bought some in the past and so when a friend actually from the Wharton School who was at a hedge fund said that, we took a look and saw what was going on. At first, we were actually arbitrage trading back in 2017. They were pretty widespread. That’s not what we do today at Bitwise but it’s what sort of gave us a reason to pay closer attention to the space to start meeting people building blockchains, to start reading about different protocols, dealing with some of the frustrations of investing in the space and deciding if this is something we wanted to root for.
Of course, we ultimately decided it was something that we wanted to contribute to and make a large part of our careers and we saw the opportunity to do that with Bitwise and so we started the company in 2017.
Laura Shin:
How did you come up with the idea for the company? What was your vision for what you wanted to build?
Hunter Horsley:
Yeah. So an experience that we had in 2017, we were, as I mentioned, trading our own portfolio and naturally having conversations with lots of friends and people. One of the things that surprised us was that a lot of people who were tech savvy, financially confident had a common remark, which was I like to invest but it’s too complicated and I don’t know how to figure it all out. Some of the people who had that viewpoint in 2017 ended up being serviced by hedge funds. But a huge portion of investors in America invest through a financial advisor in the same way that you turn to a doctor to help you with your health, mainstream Americans, wealthy families, individuals partner with a financial advisor who helps them with their investments, helps them understand what they should be doing relative to their financial goals, and we saw that there was no one focused on those people and that part of the market.
That part of the market generally invests through mutual funds and ETFs and index funds and closed-end funds and interval funds. So we saw the change to build something that opened access for a part of the market that wasn’t in a position to use products like Coin Base like Cracken but also doesn’t conventionally use venture funds or hedge funds. So that’s what we saw.
Laura Shin:
Matt, how did you come to Bitwise? What was your background?
Matt Hougan:
I was actually introduced to Bitwise by my good friend Spencer Bogart who you know from Blockchain Capital.
Laura Shin:
Who was a recent guest.
Matt Hougan:
Who was a recent guest. The funny thing about Spencer is I think I gave him his first job in the financial industry, so I hired him as an analyst when I built a company called ETF.com. So I got involved in the ETF industry in 2003, and built the largest media conference and data business in that space over a period of about 12 years. We did a lot of firsts. We built the first ETF data service, the first ETF data service. The first ETF analytics and rating service. We subsequently sold that business to Fact Set but in the process of building that I hired a team of analysts and Spencer was one of those analysts. I helped put him through the CFA series of exams and then he went on to do these great things in the crypto space. So after I sold ETF.com in 2015 and 2016 and then did an earn out, I was looking around for the next big, disruptive area of finance, the next place where I thought I could help a little bit with providing good quality information and Spencer knew Hunter and Hunter was looking for people who had expertise in indexing and ETFs to talk to.
So Spencer put Hunter and I together. I had coffee, was tremendously impressed with the team that Hunter had built. I thought the product that Bitwise was building was the only rational product for the vast majority of investors who want access to crypto. So that began a process and I was fortunate to join the day after my earn out expired on my previous company. So it was a great experience building ETF.com and excited to be part of another big, disruptive area of the financial ecosystem.
Laura Shin:
So lay out for me what Bitwise does and what your vision is for what it could become.
Hunter Horsley:
The way we think about what we’re doing, Laura, is we want to open access to crypto as an asset class for a subset of investors who today don’t have an on-ramp. So if you think but the different on-ramps or ways you can participate in the asset class today there are exchanges and apps like Coinbase, Cracken, Gemini, Bitstamp, and so on and so forth. Those are well-suited to individuals who are making decisions about their own investments as well as traders, individuals who are either hobbyist or professionally day trading.
On the other end of the spectrum you have venture funds. You had more hedge funds in 2017, it’s moving towards venture funds today in 2019 who are professional active managers. The preferred tool of endowments and other institutional allocators but in between, as I mentioned a little bit before, you have the vast majority of mainstream Americans who work with a financial advisor and the advisor can’t use a mobile app. They can’t use a web platform like Coinbase Pro. They also don’t generally use venture funds. What they use are products like mutual funds, ETFs, index funds and so on. So the goal that we have at Bitwise is to help mainstream investors understand and benefit from this asset class. So that’s partially about the products that we build that allow them to include in portfolios.
So we have a family of funds today that serve independent financial advisors, which are sometimes called RIAs, multifamily offices, family offices, and wealthy individuals. Then what comes with that though, it’s not just about the features of the fund but also being a partner to those financial advisors, analysts, CIOs and so on and so forth because it’s so much to understand and so much constantly changing about the asset class but it’s such a small allocation relative to the rest of the portfolio and then of course everyone has other things going on in life. It can be a lot to keep track of and professionals never want to be caught flat-footed. So a huge part of our responsibility and the relationship we have with clients is to make sure that we’re always informed of what’s going on and have the information they need to successfully participate in the asset class.
So we manage a family of funds and then we put out quite a bit of research, have lots of meetings and other sessions to help accomplish that.
Matt Hougan:
Yeah. I’d just tack one thing on, Laura, because it’s important and also speaks to why I joined Bitwise a couple of years ago is that the primary product we offer is an index-based strategy that’s market cap weighted and the beauty of that is that the people we’re talking to, the people Hunter is talking about, the financial advisors who don’t allocated 100 percent of their time toward crypto or 100 percent of their portfolio to crypto but use it as a small piece, those people, and in fact I’d say most people in crypto have a generalized belief that crypto and public block chains are going to be more important in the future than they are today but they don’t have a specific belief about which particular asset is going to be more important. Is it all going to be on Bitcoin? Is it going to be on Ethereum, is it going to be on something else? What the index strategy allows them to do is to make a bet that if crypto is important in the future than it is today they’ll be rewarded without having to get into this asset versus that asset, which are questions that quite honestly they’re not prepared or equipped to even investigate or have an opinion on and even if they did it’s a very hard question to ask. We’re trying to make it easy for people to have exposure.
Laura Shin:
I wanted to ask you how you make this decision for your main index I guess and fund, which tracks the top 10 crypto assets. If I were to do a quick comparison between the list of the coins on that versus either coin market cap or on-chain effects I see for coin market cap ripple, Binance coin, Bitcoin SVs, Stellar, and Tron are all missing. I’m excluding Tether because it’s a stable coin. For the Bitwise 10 you guys have Cardano, Dash, Z-Cash, Monero, Ethereum Classic but then on Coinmarketcap Z-Cash is at 30 and Onchain FX is at 33. So how do you determine which coins make the cut.
Matt Hougan:
There are two important things we do and I think they’re both very important. The first one is to screen out coins that we don’t think can be safely held by institutional investors. So they’re a group of coins. Tron is one. Bitcoin SV is another one where it’s really difficult or possibly impossible to do offline transactions with those coins and therefore having a true cold storage solution is at lease…it may be impossible. At the very least, there’s not widespread community belief in a single solution. So as a result, holding those coins in a fund or an index would expose people to the risk of loss because they can’t be custodied in the same way that other assets can be safely custodied.
So that’s an example of how we screen out certain coins. There are other screens for liquidity. We insist that coins trade on more than one exchange so that if an exchange shuts down the liquidity doesn’t vanish. So there’s a screening out process to remove coins that can’t be safely held, and we aren’t sure can be safely traded from now into the future.
Then the other piece we do is what’s called an inflation adjustment. So one thing that separates crypto from traditional market like stocks is that crypto assets are under a phase of continual issuance. There’s more Bitcoin today than there was yesterday. So the difference you’re seeing with something like Z Cash is that there’s a lot more Z Cash being issued every day and so what we do is we project five years out into the future to get a view of how much of a particular asset will exist in five years and use that as our market cap reflection with the idea that the market understands that Z Cash’s issuance is increasing rapidly and therefore it’s discounting the price.
So you have to make that sort of inflation adjustment. The end goal is to capture all assets that can be safely held, that can be safely traded and to capture it in the way that reflects the market’s true understanding of the importance of those chains. So those are the screens that get us to that end goal.
Laura Shin:
One other thing I was curious about, you guys have this Bitcoin fund and there’s also an Ethereum fund. For the bitcoin fund, how do you differentiate that from, for instance, the Gray Scale Bitcoin Trust? Is it really just the same thing but a little bit cheaper? I noticed the expense ratio is cheaper.
Hunter Horsley:
Yeah. For some clients, they have a very specific view about Bitcoin and want to pick that specific exposure. The Bitwise bitcoin fund has a few distinctions from something like GBTC. First is that it’s open ended so you can invest in the fund and then you can liquidate your investment on an ongoing basis. GBTC you’re likely familiar if you invest in the fund that’s a one-year lock-up at which point you can resell it through the over-the-counter markets to a retail buyer who then may pay you or historically has paid a premium. So the retail buyer no the brokerage, if they’re trying to buy 10 thousand dollars of Bitcoin they pay 13 thousand dollars for it. But if you invested in the private placement you’re locked up for that year and there’s no redemption.
You’re counting on that retail investor in the brokerage market wanting to buy the shares from you in a secondary. That product is obviously very popular. Our product, which also gives you exposure to Bitcoin just operates differently. There’s no second market for the shares. You can invest in the fund with us and you can redeem from us and you can do that on a weekly basis. So that’s one component and then the second component is half the price of GBTC so you caught that as well.
Laura Shin:
The thing is the fee is still kind of high if I think about it in the broader scheme of things if you compare it to mutual funds and exchanged traded funds where fees are often below one percent. And it’s just for bitcoin. It’s not even anything really fancy.
Hunter Horsley:
So there are two things that come to mind. First, it’s worth noting that our products are priced with an expense ratio, which is a unit trade fee. So just to say one sentence more on this. For a venture fund or a hedge fund what you have is a management fee, which might be two percent. Then the custodial prices, the administrative prices, those are also charged to the fund on top of the management fee. So your all-in fee is something above the management fee. For index funds, the convention is to report an expense ratio, which is an all-in fee. So the amount that Bitwise takes is a subset of the expense ratio of the fund. That includes custody and other things.
So that’s one thing that I mentioned is that’s inclusive of custody, which as you’re familiar with in the space has historically been quite a bit more expensive, orders of magnitude more expensive than hidden stocks or fixed income. The second thing I would say is I think to all of us on this call crypto is a very familiar subject matter and thought space. Bitcoin feels very straightforward at this point if you’ve been in the space for over a year. To the vast majority of people even Bitcoin is still very intimidating.
Our goal is to price it in such a way that we can be very available with research, to take meetings and to sort of be…I think for clients today they’d rather have the best heart surgeon than the cheapest heart surgeon. So even though in things like S&P 500 index funds they’re looking for sort of the cheapest option in crypto, which is new, esoteric, complicated, not their full focus. They’d rather pay more and get more hands-on service so that’s the second component of what goes into how we price the product.
Laura Shin:
Okay. One quick question before we move on to the ETF issue, which is I’m sure what everybody wants to hear about. I was curious for these funds, how do you handle things like forks or air drops that occur with any of these assets that are in the fund.
Matt Hougan:
Sure. I can take that one. I’d just add, on the fees front, maybe the more apt comparison is something like emerging market or frontier mutual funds, which often have fees above one percent. As Hunter said, people want the best heart surgeon in this space. In terms of air drops and hard forks, so our policy on air drops is pretty simple. At least historically and particularly recently there have been no meaningful air drops that have been worth the risk of gathering and liquidating. If there were one we would do that.
On the hard fork front, we evaluate each hard fork when it occurs. We monitor the trading of each new asset and if it’s safe for us from a custodial perspective to realize a hard fork we’ll do that and then we’ll liquidate it and the proceeds get distributed. So we make sure that our investors are exposed or get the full benefit of hard forks but we do so in a way that we check to make sure it can be done safely from a custody perspective.
Matt Hougan:
The other thing I would add, Laura, on this front and as it pertains to some of the earlier questions about what ends up going into the index is that it’s a public set of rules that governs what’s held in the fund. On our website, Bitwiseinvestments.com you can click and actually read through the full public methodology document that stipulates all these different rules. Again, they’re all striving to give investors exposure to the asset class while making sure that it’s holding things that are at a level of maturity that’s feasible for it to be done securely to expect future liquidity and so on and so forth.
There’s a governance board that also influences the rules of the index. Matt sits on that board. The former head of indexing for Bloomberg, former head of research for S&P, who sat on the S&P 500 Index Committee for 10 years sits on that board and actually Spencer Bogart sits on that board as well. There’s a public set of rules. We’re not just sort of making ad hoc decisions here. The spirit of those rules is again to weed out some of the things that might appear highly ranked on a website but don’t have the characteristics that make it safe for a mainstream investor and then those rules have governance so that they can change over time if need be.
The last thing I would add is that we also intervene if there are ad hoc events. So when EOS announced its main net launch back June 6 of last year, they were going to launch the main net, which meant that they were going to freeze trading for a period of time. We convened and rolled it out of the index because liquidity is a requirement of being in the index. So we know things that sort of happen suddenly, we convene to address those as well.
Laura Shin:
Let’s move on to the SEC decision because this is what everybody wants to talk about I’m sure. I want to hear what your response is to the SEC’s 112-page rationale for why it did not approve your ETF application.
Matt Hougan:
Sure. I’ll take first pass and you can add on, Hunter. Really, we’re extraordinarily pleased that they went to 112 pages’ worth of depth into their view on our application and the pathway forward. The real risk in this process would be that we’d get back a cursory review that didn’t lay out what needs to happen in order to move the ball forward and that’s not what we got. We got 112 pages, some of them toughly worded but importantly they laid out a pretty clear path for Bitwise or other providers to pursue if they wanted to advance things. If you think back over the course of ETF applications that have been on file, this is really the second major response. The Winkle Voss paper got I think it was 96 pages, so we edged them out by a couple dozen pages.
That was a great step forward for the industry as well. It showed that the particular path they were taking was not the path the SEC wanted to see. They didn’t like the idea of pricing on a single exchange. They thought there was risks that the ETF would overwhelm that market. They raise this specter of how you might move forward, which is to search for regulated market of significant size that could trade alongside the spot bitcoin market. So our application took that and ran with it. We argued that the CME bitcoin futures market was a regulated market of significant size. What the SEC came back and said was that the results were inconclusive. They need more data. They need more data on where price discovery occurs and they possibly need more surveillance sharing or agreements with underlying spot bitcoin exchanges.
But the important thing was they really were clear in terms of what analysis they need next for us to move the ball down the road and that’s what we intend to do.
Laura Shin:
Yeah. I actually ant to dig into those points a little bit because I actually thought a lot of what they said here, they had very strong arguments. I’m just going to pull out a few of the ones that struck me. For instance, they said that your report, because you had kind of separated out the exchanges of real volume versus fake volume. They said that you were then assuming that for instance significant volume on new platforms would be fake or non-economic volume. There was another one where they said that your rationale for assuming the volume and the OTC dark pool market was not significant was also flimsy.
They objected to the fact that you excluded the South Korean exchanges because of capital controls. What they said here is that doesn’t mean that the trading volume in South Korea isn’t real. There were a bunch where I was like good point, good point, but those were just a few that caught my eye. What is your response to some of these particular things and how would you restructure your proposal going forward?
Hunter Horsley:
I think Matt can chime in on some of those topics. I just want to sort of establish the context is the backdrop is this is productive. We file and then try and present the information that we think will be supportive of the things that ultimately they want to get comfortable with before they say we’re signing off on having diligence to this. We make an attempt to do that in the most useful way but we want to hear feedback. So it comes through this sort of back and forth. To Matt’s point before, what’s important is that there is feedback and that it’s granular and we can act on it. It doesn’t need to be the case that everything we put forth was perfect on the face of it. I think the really important thing for us was that we got a lot of feedback on where we should be focused and the things that resonated and things that didn’t.
Laura Shin:
So how would you address some of these points that I brought up?
Matt Hougan:
Those are great questions. Some of them were great points. Some of them we have a huge amount of additional data we’d like to provide. I think the argument with the fake volume piece was a relative size argument. We were saying fake volume is a well-established problem in the crypto market. It’s not that Bitwise was the only firm that’s investigated this. A number of firms have looked at this and agree that there’s a huge problem with fake volume in the market.
So what we did was try to systematically analyze it and say the actual spot bitcoin market is not so big it’s significantly smaller. As a result, the CME futures market looks significant so out point was that when you scaled the bitcoin spot market appropriately the CME futures market was about 20 to 40 percent as big and our view was that that relative size argument showed that it was significant.
Laura Shin:
Right. But I think the SEC was saying that you didn’t provide enough evidence for them to know what the real size of the market was because for instance this issue about the gray area between real and fake. You did concede that on some of these “fake” exchanges that some percentage of that volume must be real but you didn’t know what it was. There were multiple points where they were saying like you didn’t actually prove that you know what the real size of the market is.
Matt Hougan:
That’s absolutely right. They also wanted…
Laura Shin:
So you can’t say that the CME volume is significant. Do you know what I’m saying?
Matt Hougan:
I do know what you’re saying. I’m actually going a step further. So they asked for additional data and we’d be happy to provide that data. And some of the points that they made were valid but what I think the important thing was actually if you read through the entirety of their response is toward the end in the last 20 pages where they effectively argue that the relative size argument may not be the winning argument. Even if we had convinced them that the real size of the market was X and the real size of the CME futures market was Y they’re not sure that that would solve their problem. It could be that even reported volume on fully fraudulent exchanges or totally fake volume could still influence the price. So the direction they’re actually pushing is to do analysis on prices from across the spectrum to find out where price discover occurs. That’s almost regardless of whether we convince them that the size of the market is X and not Y.
So there’s a huge amount more data that we can provide on the size of the market and it would be great to have more independent third party verification and some of their arguments I sort of fundamentally disagree with or think miss the point. Those are almost not what they want to see going forward. What they want to see going forward is regardless of what you’re saying about fake volume, for all these places that are reporting prices where is price discovery occurring? They laid that out pretty clearly at the tail end of the session, which focused on the question of what is a significant market. So there’s great work to be done but there is this nice pathway forward.
Laura Shin:
So let’s discuss that in a moment. But first a quick word from the sponsors who make this show possible.
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Laura Shin:
Back to my conversation with Hunter and Matt. So tell me, there at the end where they were saying where they would like to go. Where are you thinking that you then will go for your next proposal?
Matt Hougan:
Yeah. We’re researching it right now. Hunter, feel free to jump in, but they laid out the phrase they used. The sort of magical phrase in their response is the word lead lag analysis. Lead lag analysis you can think of if you have two exchanges and they’re both tracking the same thing. Say, bitcoin. Which one goes up first and the other one follows is the exchange that leads. That’s one way of looking at where price discovery occurs if you examine two exchanges. There are other academic ways of looking at it as well. The sort of goal is to find one or more regulated, surveilled markets that collectively are where the majority of price discovery occurs in the market. So that’s one avenue of research that we’re going to pursue and I assume that’s one avenue of research that other people who have looked at this are going to pursue.
Laura Shin:
Wait, I’m sorry, how is that different from how you identify those 10 exchanges? I guess not all of them are regulated.
Hunter Horsley:
So we looked at it through a relative size lens, which Matt referred to before, which is we said what is the amount of volume taking place on exchanges that we can conservatively say have real volume and then what are the comparative sizes of those markets, and CME is very large. I think what Matt was just conveying is the SEC had some comments on the methodology there. Maybe certain things should be included or not. Great. We can make changes there. But more over that regardless of relative size they’re also interested in understanding, again, regardless of size, where does the price go up first or where does I go down first? Does it go up on Coinbase first and the Gemini follows and Bitstamp follows and Binance follows or does it go up on Cracken first or so on and so forth. So that’s the lead lag analysis that Matt’s describing and that they’re saying regardless of how much volume is taking place on different exchanges they’d like to have a clear understanding of where the price is forming first that then gets arbitraged and traded into the rest of the market.
Matt Hougan:
Right. That gets to their sort of core point, which goes through the history of ETFs that they’ve approved, which is you need to be able to have a surveillance sharing agreement between the exchange where the ETF is listing, in our case NYSE Arca and a market of significant size that’s regulated and the significance is driven by is that market a market where price discovery occurs. What the SEC is trying to prevent is someone being able to manipulate, say, the bitcoin market on a market that cannot be surveilled.
That’s the difficulty that they’re worried about and that’s the research that we’re pushing towards to solve.
Laura Shin:
I was wondering if that concern was sort of proved out this summer with that situation that happened with Bitstamp and Bitmex. I don’t know if you guys followed that where basically a trader placed a larger order in Bitstamp to crash the price there. Because I guess Bitsamp’s price is referenced for Bitmex that enabled the trader to essentially make a killing with a short on Bitmex. So I know this is a little bit different because Bitmex so it’s no exactly what you were looking at. I just assume that sort of proves the SEC’s point that you can engage in similar tricks. Is that true?
Hunter Horsley:
So I think the general thing of where does the price move first is the right thing, which is if the price moved on Bitstamp first and that’s generally the case then they want to understand that Bitstamp tends to be the venue where the price moves first. So that is the nature of what they’re interested in understanding better.
Matt Hougan:
Yeah. Importantly, Bitstamp has a bit license, which has market surveillance requirements built in. The ecosystem, and this is a point I’ve made a number of times is evolving rapidly. What was true two years ago is no longer true today. So there’s increased regulation of a larger number of crypto exchanges. There’s the potential for surveillance sharing to occur on those exchanges. There’s at least sort of the regulatory requirement through the bit license for surveillance to be mandated on a number of those exchanges. So you have to look at both the activity and then the ability to surveil and consider and review what happened on those exchanges. That’s really what the SEC is concerned about.
Laura Shin:
Oh, interesting. So we’ve been kind of talking about these spot markets but I actually want to flip sides because as you probably remember back in July 2018 when the Winkle Voss bitcoin ETF decision was made, SEC commissioner Hester Pierce wrote a descent where she basically said the SEC shouldn’t even be focused on the underlying bitcoin spot market at all. She said that to her mind the correct interpretation of the Securities Exchange Act of 1934 was that the exchange should determine manipulation on the exchange-traded product itself but not in the underlying marketing. She said, “indeed if the disapproval orders rigorous standard were applied consistently many commodity-based ETPs would be in peril.” So do you agree with her there that the SEC kind of incorrectly and inconsistently applied this standard?
Hunter Horsley:
I think ultimately, the commissioners that sit today are focused not on protecting investors going forward. So I think that there are some people who make arguments that this product from the past is pretty ugly. How then can you not give a bitcoin product a change. I think the commissioners sitting today are focused on going forward how do we make sure that investors are protected. So I think some of those arguments resonate less well even if there is merit in some of them because they want the future products and future actions to be bulletproof.
Laura Shin:
So you think it is correct for them to have focused on the underlying spot market?
Matt Hougan:
I think it’s fair and reasonable. I think Commissioner Pierce’s argument is also interesting and reasonable. The way to think of the SEC is almost the way to think of the FDA. Their first do no harm regulator, they want to make sure that retail investors are protected and if we back pedal a few years I think even Bitwise would agree that the bitcoin market was not ready to support an ETF. There were no regulated, ensured custodians. There was large arbitrage gaps in the bitcoin market. So it’s not like they’re asking in appropriate questions. We obviously think the market has matured to the point where it can now fully support an ETP but again I think they’re getting after it for the right point.
Laura Shin:
I wanted to also ask about this VanEck decision to withdraw their proposal rather than wait for the rejection from the SEC. I was just curious, in the days leading up to the decision about the Bitwise ETF did you kind of know already the outcome but decided not to withdraw or did you not know the outcome so that’s why you didn’t withdraw? In general, how much in the dark were you guys throughout this whole process?
Matt Hougan:
Our view was that we wanted to get 112 pages from the SEC. So we didn’t know what would happen at the end of our review period. But our view was that either outcome, either approval or disapproval with detailed commentary would be a major positive step forward and that the only negative outcome would be if we didn’t learn anything from this process about how we move forward. So we’re happy to take it all the way through to disapproval to get these 112 pages of feedback because they form the foundation of what happens next both in our efforts and the broader industry’s efforts to move forward on the ETP question.
Laura Shin:
One other thing I wanted to ask about was after the decision, Jake Chervinsky, who’s the general counsel at Compound and he’s also a former securities lawyer. He tweeted, “at this point, it’s reasonable to assume that Jay Clayton’s SEC will never approve a bitcoin ETF. His term ends on June 5, 2021 but could go another 18 months longer. Usually, we’ve seen new ETF proposals filed immediately after rejection but it might be time to take a year off.” Do you guys agree with Jake?
Hunter Horsley:
I don’t agree and I’d be curious for your thoughts, Matt. I mean I think our experience of the staff and the commissioners has been that they’re open minded. I mean even if you just contrast Commissioner Clayton did an interview with Bob Pasani on September 9, and Bob’s interviewed Jay a few times and said, Jay, are we ever going to see a bitcoin ETF? Has any progress been made? Jay said the short answer is yes but there’s still questions that have to be worked through. I think our experience has been that they’ve been collaborative and are definitely listening to points that are being made and are honing in on their argument.
I mean just even last year in 2018, a lot of the focus you’ll recall…I mean, Laura, you in particularly will definitely recall everyone was talking about qualified custody, custody of these assets, what is a qualified custodian. You’ll notice that that’s absent from the focus of the 112 pages where the SEC lays out the things most on their mind today. I think we’ve seen definitely that they’re attentive, that they’re open to hearing arguments. They’re going to give you strong feedback. To take a step way back, we’re talking about Bitwise wants to introduce an ETF to open up the market to mainstream investors. I think for everyone in the space crypto is a pretty new space. I think the things that the SEC is calling attention to, certainly they have bearing on an ETF but I think for anyone who’s involved in crypto as an investor, not just a user they’re bringing attention to issues that need to develop, need to mature if investors want this to really grow into a mainstream and institutional asset class. I think even people who are comfortable investing on Coinbase’s mobile app or another venue, I think they’d all like to see more liquidity, more institutional participation, a higher market cap, more regulation. For those things to happen, the issues that the SEC is calling attention to need to see improvement. If the industry stays as it is today I think many of the people in the market today expect and want that improvement.
Laura Shin:
All right. One other thing that I wanted to ask about was early on it sort of feels like the SEC kind of spelled out what they needed to get a bitcoin ETF approved, and they harped on this idea that there needed to be at least one significant regulated market for trading futures on the underlying market for trading futures on the underlying commodity and that the ETP listing exchange has to enter into this surveillance sharing agreement with that market. You sort of alluded to this but I just wanted to know now that you know this, how is this going to inform your next proposal?
Matt Hougan:
Sure. That’s a great question. It can be more than one market, to be clear. So the CME futures market is one example. The new backed market is another example. You could consider ETPs in other jurisdictions. At least in the 112 pages it raised the specter of having market surveillance agreements with the actual underlying spot exchanges. It doesn’t have to be a derivatives exchange. It just has to be a regulated market of significant size. So as you think about here we and other people go forward from here, I think the goal is to build up one or a group of exchanges where you can have surveillance sharing agreements in place such that you feel confident that those are the significant markets where price discovery is occurring.
The continued growth of the CME bitcoin futures market is going to be part of that backed maybe part of that. Other exchanges may be part of that but that’s sort of where the magic answer for the SEC lies is to have enough of the market be regulated and surveilled with sharing your agreements in place for them to feel comfortable that market manipulation won’t occur without it being able to be investigated, corrected and enforced.
Laura Shin:
So we’ve gone really deep on your products and we’ve also obviously now covered this bitcoin ETF but I want to kind of take a step back and ask you about your thesis about how the crypto space will development generally. So we’ve got the people who say there will be one chain to rule them all. There are others that say there’s just going to be a few valuable protocols. Even if I look at your 10 large cap crypto fund it’s like okay, there’s a strong argument to be made for bitcoin and Ethereum and others. I’m at a little bit of a loss. Maybe if you really stretch it you could add Monero. I’m not saying I don’t doubt that someday we’ll end up with at least a few more significant chains but do you think that we’ll really end up with 10 really big ones and if so is that going to happen in anything less than a decade? And yet you’ve also got this index for the top 100 and stuff like that. Those coins are even less kind of proven.
What does the future look like to you and why are you kind of laying the ground work for these products that it’s just at this moment not clear at all that anybody will even consider those “investable assets.”
Hunter Horsley:
The first thing, we have indexes that people use for benchmarking so the Bitwise 10 large cap, the Bitwise 20 mid cap, 70 small cap, and 100 total market. In terms of funds that people invest in we only have the 10 large cap and then the bitcoin and Ethereum fund.
Laura Shin:
Right. But you do ask people to contact you if they’re interested in…it seems like you’re trying to gage the interest.
Hunter Horsley:
We’re always interested in how people want to access the market. The uncertainty that you’re describing is the main point, Laura. So our large cap index holds a huge proportion of bitcoin because that’s the most developed and highly valued public blockchain today. Some people think that there will be competitors. Some people think that there are hedge cases that could impact bitcoin. Other people think that that’s the steamroller that all of the value will consolidate around. You could deal with that uncertainty one of two ways. You could have a lot of conversations, do a bunch of reading and then pick which side you fall on. Or you could run a strategy where you benefit in either case. That’s what our index strategy provides for investors.
If in 2014 they thought that bitcoin would be the only thing and never could they imagine something like Ethereum and so they only held bitcoin. Then they missed out on the opportunity of Ethereum. But it’s possible that we’ll see other really valuable and useful public blockchains, it’s also possible that we’ll see consolidation around some of the larger ones we have today.
Matt Hougan:
I would just tag on to that, my view of how the crypto market is going to unfold sounds like it’s very similar to yours, Laura. I think there’ll be a handful of very important coins that are sort of generationally important. I think it’s highly likely bitcoin and Ethereum are two of those but I think there’ll be a couple more with various particular use cases. The beauty of the index strategy, because it’s unconstrained, because it doesn’t cap the weight of any particular asset is that it evolves naturally to invest more and more in those assets as they become more and more important. So I think it’s entirely possible that 10 years from now there’s even greater concentration in the top five or six assets than there are today. I don’t know exactly which those assets will be.
The reason we have 10 is it captures enough assets to let you sleep easily knowing you’ll be exposed to whatever is becoming the winner in the space. The reason we don’t constrain the weights the way some other indexes do is because we realize that this could be a winner take all or a winner take most market. So the strategy is sort of optimized around that.
Laura Shin:
So do you have thoughts around how to value these different crypto assets? As I’m sure you’re aware there are a lot of different ways people are trying to analyze these such as the NVT ratio, the network valued transactions ratio, which is basically network value divided by USD volume. Chris Burniske has actually been on my show talking about how he uses the equation of exchange MV=PQ as a way to analyze them. So what are you guys using when you try to value these networks or what is your thinking about how best to do that?
Hunter Horsley:
Those are all well-known approaches to valuing assets. There are others like technical analysis, looking at sentiment. I think the reality that everyone in the space is aware of is that there’s no one agreed upon fundamental today. Ultimately, the underlying dynamic is a supply and demand dynamic. So if demand out-paces the amount of new supply coming online through the block rewards then the price goes up and vice versa. This is one of the reasons that people look with such high anticipation to the having of the bitcoin block reward next year where every year instead of four percent of the total supply being mind it’ll drop to a little under two percent, which is almost the difference between the rate at which silver is mined dropping to the rate at which gold is mined.
Laura Shin:
Hunter, I mean the supply and demand thing is so simple that even a pump and dump scheme could look like a valuable investment at some point. There’s a lot of ways that a lot of these different projects are actually gaming that idea.
Hunter Horsley:
Yes. That’s ultimately what creates volatility in the market is it is a function of supply and demand and even though supply changes at a constant programmed rate the demand changes at different rates again based on…there might be one trader who’s looking at technical analysis. There might be somebody else who’s looking at an NVT ratio and there might be someone else yet who’s not really looking at any of those things and is just buying it for the qualitative thesis that this thing will be more important in the future than it is today. That creates an inconsistency in the amount of demand or buy orders on any given day. That creates a volatility. I think there’s no silver bullet answer here. I don’t expect in six months the industry will arrive on a price earnings like way of valuing assets in the same way, if you think about residential real estate in your city, somebody might say the most important thing is a view and somebody else might say the most important thing is the bathroom. Somebody else might say the most important thing is the block or the neighborhood.
Somebody else might say the most important thing is the macro economy and how many people actually moving each year and all of those things have some amount of merit. I think that that’s the difficult reality that crypto assets as digital commodities have in terms of being valued which is you have to try and construct a view about future demand. Then the supply piece for most public block chains is more straightforward. But I don’t anticipate any time soon the market that’s trading agreeing on one metric to create a floor around.
Matt Hougan:
I think that’s right. I would just add both for myself and for most of the investors that we talk to, they see this not as a short-term holding but as a long-term investment. If you think about something like bitcoin as a long-term investment the addressable market it’s going after even as just the first digital store value is so much larger than its current market capitalization. It’s 50, 100, 200 times the current market valuation that you’re really talking about how much you’re discounting the likelihood that it achieves that place in the world. There’s so many factors that go into that discount. Regulatory factors, political factors, technology advancements, wallet adoption, custodial developments, adoption, ETF approval or not. All of those have their own sort of discount rates. Most of the people I think just look at something like bitcoin or Ethereum or some of the other assets and say they’re so early and they’re going after such large markets and the discount rates currently are so large and variables so many that it’s really hard to assign any particular value.
The important thing is just to make a small allocation to the space and hold on to it for the long-term. The fortunate thing for investors is that it has these wonderful benefits that come with that allocation in terms of it not having correlation to the other assets in their portfolio in terms of the ability to rebalance on a discipline basis. Valuation targets are really hard. I think the important thing is the addressable market that these assets are going after are huge, orders of magnitude larger than the current market capitalization. That’s the thing I think investors should keep in mind.
Laura Shin:
Bitwise is going about its strategy in a very traditional way, a way that’s recognizable to somebody who has had a career in finance. Meanwhile, we’re seeing a lot of experimentation in the defi space where it looks the smart contracts could very well do exactly what it is that you guys are doing with your funds and indices. Do you ever see yourselves going in that direction? Would you ever offer smart contract versions of your funds? What would that even look like?
Hunter Horsley:
I think there’s a ton of exciting things being developed in the defi component of the industry. I almost sometimes feel like there’s almost two different parts of the crypto industry. There are people who are really pushing the envelope in what’s possible if you think about compound and dye and some parts of defi. Then there’s firms like ours that are sort of trying to introduce public block chains and bitcoin and crypto to the world for the first time. To answer your question specifically absolutely we’d be open to structuring a solution in whatever way best empowers the audiences that we’re seeking to serve to be able to participate in the asset class. Today, I absolutely do not think that that’s a smart contract. Understanding bitcoin is in and of itself still a complicated project for many investors. The last thing they want is to also complicate this structure that they’re using to get exposure to that asset. I do think that it makes sense for some investors if over time it becomes a better and better mechanism then there’s no reason we’d be opposed to it.
Laura Shin:
A lot of people were excited about the launch of Bakkt. You would often see on Twitter people would be like when Backed but then of course when Bakkt actually launched it was pretty anti-climactic. Why do you think that was and how does that affect Bitwise’s business in the sense that I feel like that’s a sort of similar market to you guys or at least the target market?
Matt Hougan:
I think there are two reasons why it was anti-climactic. First, expectations had gotten way out of hand. If you look back even at the CME and CBOE futures markets when they launched, their initial volumes were very small. People were disappointed. The reality of futures contracts is they take time for liquidity to build in the market, particularly for something like backed, which wasn’t even approved at a lot of national futures wire houses. So there were a huge group of investors who couldn’t even participate in that market. I think it’s way too early to write off backed just like it was way too early to write off CME or CBOE when they had very tepid volumes in December 2017.
The other reality is it’s tough to be second to market in the futures space. So there are technical differences between the CME contracted and the Backed contract. One settles physically. One settles for cash purposes. But for major uses of futures like arbitrage, short-term holding that difference doesn’t make that big a difference. So you have a new futures contract competing with an existing futures contract. I go back to my ETF days where the first ETF to market in any area tends to get the lion’s share of the assets and it’s very difficult for second to market ETFs to nibble into that market share. They can do so over time but it takes a lot of time. I think that’s true here. The futures market tends to be a monopoly market. Backed it trying to eat into the CME’s lead by having a differentiated contract and physical settlement but that’s going to take a long time to play out.
I think it’s too early to write it off. I also think they face more challenges than maybe the market anticipated. I do think conversely when you look at something either like private funds or an ETF those are still undeveloped markets. So I think there’s significant demand for a crypto ETF because it will fit into the workflow of financial advisors, which control about half the wealth in the US and currently have very limited allocations to crypto.
So I think the market just got ahead of its skis on backed and I think if we look at this in a year we may be telling a different story.
Hunter Horsley:
I’ve said this a few times but I think it’s just constantly important to remind ourselves that as people working full time in crypto there’s so much going on, take it very seriously. For an institutional allocator this is not their top priority. So even for the institutions, be it asset managers, hedge funds who will end up taking advantage of Back’s future contracts they have other things going on. They only convene as an investment committee every so often. So it’s not the case that they’re sort of scrambling to invest on the first day that a product launches. It’s important that the door is now open for that tool to be something that they can use. Generally speaking, institutional allocators are not moving at the pace of investment products but they’re moving at their own pace. So once the investment products are an option they can consider them.
I think there are a lot of people who will be interested in the Backed futures who didn’t come in on day one because they had other things going on. That’s something we constantly encounter with our client base, which is crypto is less so that Ethereum is competing with bitcoin or a hedge fund is competing with a venture fund and more so that crypto as an asset class is competing with domestic equities, international equities, emerging markets, high-yield tech, investment grade bonds, munis that make up 99, 95 percent of people’s portfolios, so I think that is important, too.
Laura Shin:
That got me curious because I noticed for instance your Bitwise 10 private index fund became available in November 2017 and the returns have pretty much all been negative ever since. So I just wondered, do you feel…are you noticing that your LPs are sort of expressing regret for getting in or is it hard for you to attract new LPs. How has this crypto winter sort of affected?
Hunter Horsley:
We’ve had inflows every week for almost two years. Of our existing clients, something like 20 percent have increased their exposure. The retention of clients who’ve been invested for over a year is north of 95 percent. I think for clients in our funds it is a bit more of an intentional investment. It requires more effort and intentionality than saying buying or selling some Ethereum on a mobile app. Our clients generally have a thesis and that thesis is generally a multi-year time horizon. So that’s what we’ve seen play out, which is investors topping up when prices come down generally the vast majority of investors still in the fund and then new investors have come in every week for almost two years now.
We’ve seen more interest amongst professional investors, mid-2018 through today than we did in 2017. So there’s been some shift in the audiences that are most excited about crypto but that’s what we’ve seen so far. The other think I would not, Laura, that’s important is funds have an inception date but returns depend on when you invest in the market. An investor in bitcoin who bought at 18 thousand has a different return over the last two years than an investors who bought it at four thousand and 2018. So there are people since 2017 who have very positive returns.
Laura Shin:
One other thing that I wanted to ask is obviously you guys are working on this bitcoin ETF, which would then enable people to have exposure to bitcoin in a tax advantaged account and put it toward, for instance their retirement. But I was curious about these other products that are already out there. I noticed there are these bitcoin IRAs. Describe how those work and give us your take on those.
Matt Hougan:
Go for it, Hunter.
Hunter Horsley:
There’s some products out there that mark themselves as helping you put crypto in an IRA. Then they facilitate the purchase and then the custody of that crypto into your IRA. They’re not funds so it’s better to think of them as brokers or services. I think both Matt and I and if you ask many other people in the space have a certain amount of frustration with some of these services without naming specific ones, one of the most popular, take something like a 10 or 15 percent up front fee. So if you’re not reading the fine print and you go to invest 10 thousand dollars in bitcoin they take 15 hundred dollars to buy it and then put it in a custodian for you and then the custodian charges you a custody fee.
So the positive lens is crypto is a very new space and anyone who is working to increase access so they’re not just tech savvy individuals or the financially savvy can participate, ultimately we’re a fan of. So anyone who’s trying to bring new options. Sometimes the options are less than optimal and it can be hard for individuals to discern when they’re dealing with a new service provider or a new product that they’ve never heard of before. Sometimes there’s a bit of a mismatch and they’re not well-equipped to fare well in that interaction.
This won’t come as a surprise to people but there’re definitely some services in the crypto space that I would say are a little bit predatory. Our view is that for the vast majority of mainstream Americans it will make sense for them to work with their financial advisor in the same way that they work with their financial advisor for every other asset class. They work with the financial advisor for high-yield debt. They work with them for investment grade bonds, for small caps, large caps. It’s exciting and necessary that there’s a lot of enthusiasm to learn about crypto and to take action yourself. I think for it to become a sustainable asset class it can’t be the case that every investor is picking investment solutions themselves, deciding if they think EOS or Ethereum has more merit if they think that bitcoin is dead and Ripple is king or Ripple is dead and bitcoin is king.
I think there’s a lot of exciting things to think about but I think ultimately to be a sustainable asset class it needs to converge on roughly the same set of ways you approach other asset classes as well. To bring it back to specific providers there’re providers out there. It’s great that people are working to create more ways to participate in crypto but some of them do have what I would consider fairly predatory promotion and then fee structures.
Laura Shin:
The one I learned about took 15 percent and I was like oh, okay, this is like highway robbery.
Hunter Horsley:
That’s really not…I think there’s no way in looking at that in which you say that’s anything other than fairly predatory.
Laura Shin:
Yeah. All right. Well, this has been a great conversation. Where can people learn more about each of you as well as Bitwise.
Hunter Horsley:
So the website is Bitwiseinvestments.com. The firm is on Twitter, Bitwiseinvest. I’m @HHorsley. Matt is @Matt_Hougan on Twitter.
Laura Shin:
Great. Thank you both so much for coming on Unchained.
Hunter Horsley:
Thank you, Laura. Total pleasure.
Matt Hougan:
Yeah. Thanks for having us this was fun.
Laura Shin:
That’s so much for joining us today. To learn more about Hunter, Matt, and Bitwise check out the show notes inside your podcast player. If you’re not yet subscribed to my other podcast, Unconfirmed, which is shorter, a bit newsier, and now features a short news recap be sure to check that out. Also, find out what I think are the top crypto stories each week by signing up for my email newsletter at Unchainedpodcast.com. Unchained is produced by me, Laura Shin with help from Fractal Recording, Anthony Yoon, Daniel Nuss, and Josh Durham. Thanks for listening.
