Show notes
How to value a crypto assetBook: Bitcoin and Beyond Chris’s Medium post on crypto asset valuations
Transcript
Laura Shin:
Hi, everyone. Welcome to Unchained, the podcast where we hear from innovators, pioneers, and thought leaders in the world of blockchain and cryptocurrency. I’m your host, Laura Shin, a senior editor at Forbes, covering all things crypto. If you’ve been enjoying this podcast, please help get the word out about the show. Share it on Facebook, Twitter, or in your secret Slack and Telegram channels, and if you have a chance, give the show a rating or review on iTunes, and don’t forget to follow me on Twitter, @LauraShin.
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My guest today is Chris Burniske, Cofounder and Partner of crypto venture capital firm Placeholder Ventures and the coauthor of the soon to be released book, Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond. Welcome, Chris.
Chris Burniske:
Thanks for having me, Laura.
Laura Shin:
Chris, you are the first guest to come back on the show. How do you feel about that?
Chris Burniske:
That’s very exciting. That means Unchained is going strong.
Laura Shin:
Does it, because you came back on the show?
Chris Burniske:
No, it just means there’s been, you know, given the rate of progression in the crypto space, Unchained has been around for 10 years now, right?
Laura Shin:
Yeah. Someone was saying to me that a quarter in the crypto world is equivalent to a year in the real world.
Chris Burniske:
Right, or it’s the acceleration of dog years, right? One typical year is seven dog years. One typical year is 14 crypto years, or however you want to go about it.
Laura Shin:
Oh, wow, okay, and by that measure, Unchained has been around for 20 years. Okay, so, as you can see, there’s been a lot that’s changed since you were on in that previous episode. For people who haven’t listened to that, that was one where Chris was on the show with Adam White of Coinbase, and they talked about Bitcoin representing a new asset class. In today’s episode, we’ll dive even deeper into valuating this new asset class, but before we get there, I actually wanted to ask you, Chris, a little bit more about your personal background because we didn’t go into that when you were on Unchained the first time. So, why don’t you tell us about how you got into Bitcoin and cryptocurrency?
Chris Burniske:
Sure. A friend, an enthusiastic friend, dragged me down the crypto rabbit hole in college in early 2012. I was at Stanford at the time, and so a tech-focused campus, and there were pockets of interest here and there. It didn’t stick with me. At the time, I was intrigued and interested, but there wasn’t the infrastructure and community around Bitcoin at that time that there is now. For example, Coinbase wasn’t even around. It was really just Mt. Gox, and your main major application of Bitcoin was the Silk Road, and it was hard to dissociate, you know, Bitcoin from the Silk Road at first blush.
A couple years passed, and you know I stayed interested in the space, never considered it professionally until I joined ARK Invest in 2014, and I joined ARK as a next-generation internet analyst, and ARK was a startup at that time, just getting off the ground, didn’t even have funds trading, and so I got the opportunity to help design, along with our portfolio manager, Cathy Wood, and director of research, Brett Winton, ARK’s next-generation internet strategy, and as a thematic strategy, it includes elements like machine learning, cloud computing, Internet of Things, and it was clear to us that we wanted to include cryptocurrency in there, but since this was mid-2014, there weren’t any instruments for ARK, as a public fund manager, to get direct exposure to crypto assets.
So, we held things like Taiwan Semiconductor, which the fabrication plants of that firm are used for some of the ASICs and GPUs that are used to mine crypto assets, or NVIDIA, you know, one of the classic GPU producers. Then we were approached by Grayscale, actually late in 2014, because they had the Bitcoin Investment Trust that would shortly become a publicly traded instrument in GBTC, and that justified me doing a deep, deep dive on Bitcoin, which really dragged me down the rabbit hole, and so I ended up transitioning to focus on the space exclusively really because I lost interest in the equities that I was covering, and in September 2015, ARK became the first public fund manager to make an investment, a direct investment, in Bitcoin through Grayscale’s Bitcoin Investment Trust, and then since then I’ve been doing a lot of research, writing, speaking on the space. You mentioned the book, which is now out, which is exciting, and have started a firm with Joel Monegro, formerly from Union Square Ventures, called Placeholder.
Laura Shin:
Okay. Wow. That’s quite the journey, and I think something that’s interesting for listeners to know, and this is something that Chris and I have bonded over, is that you were interested in doing something with like environmental science, right? Isn’t that what you studied at Stanford?
Chris Burniske:
Yes. You know I grew up a nature boy, little-known fact. I’m still a hippie. I may be a closet hippie, but I lived in Hawaii when I was 12 to 18 and picked up surfing there and always had that sort of slant from my dad, who was big into nature. So, I studied biochem and physics all around the ocean in college, had no conception of working in finance, no desire. It was actually probably the last place I expected to find myself working, but in a large sense that was because I had stereotyped the entire industry, and finance was just this one big black blob, and as I came to learn more about it through ARK, I realized, you know, there are many nuances and many verticals within the financial services industry.
Laura Shin:
And so during your time at ARK, and can you remind me what year did you join?
Chris Burniske:
I joined in 2014.
Laura Shin:
Okay. Yeah. So, you know, that was like shortly after…or 2014 was, I guess, the year that started with the big Mt. Gox implosion, where almost half a billion dollars’ worth of Bitcoin was lost.
Chris Burniske:
Yeah.
Laura Shin:
And then the price just sort of steadily declined up until…I think it was like early 2015, and then it like languished at around the same kind of in the low 200s for a long time. So, I’m just kind of curious, like, while you were at ARK, how did you see Bitcoin and crypto assets change and how did your thinking around them change as well?
Chris Burniske:
You know it was fascinating because 2014 was a dark year, right? Bitcoin was not cool in the way that Bitcoin is cool in 2017 because, exactly as you’ve said, November 2013, Bitcoin hits 1242 dollars, you know, we’re well on our way to the moon, everyone is super excited, then there’s a number of things that happen from, you know, China’s statement that this isn’t a real currency with real meaning to Mt. Gox, and that precipitates this slide all the way to…Bitcoin lost 85 percent of its value, fell to 175 dollars by January of 2015, and sort of in that period is when I am doing my due diligence on Bitcoin, right, and then through 2015, as you mentioned, Bitcoin sort of was in this trading range of 200 to 300 dollars, and so what was great about that for me, coming from ARK, as a technology analyst, was there was no hype, right?
It was really just a deep investigation of the technology and the merits of Bitcoin as money over IP, and so that led me to do things like…one of the first papers I put out is called Bitcoin, securing the network, looking at the long-run security model for Bitcoin miners when basically block rewards phase out or the issuance of new Bitcoin phases out and is supplanted purely by transaction fees. So, that’s just one example of, you know, ARK’s approach was really to develop deep conviction in the technology and also in the price of Bitcoin and the potential for appreciation, because as a fiduciary, ARK has to do that, and that just allowed us to develop a really robust base free from all the hype, but then, you know, when we made the investment in September of 2015 and put GBTC, the Bitcoin Investment Trust, into two of our CTFs, we drew a lot of fire. We probably drew more negative reactions than positive fanfare, people saying, I mean, you have to remember in that time, too, that was blockchain, not Bitcoin season.
That was when, you know, much of the financial services considered these native assets to be irrelevant or a distraction at best, and so we had tons of people saying you consider yourself to be a specialist in technology, you’re missing the boat here, like, it’s not about Bitcoin anymore, that’s, you know, so 2013, it’s about blockchain. And so that just led me to dig my heels into the ground more and more and more, and also at this time is when Ethereum is kind of percolating, right? Ethereum’s network goes live in the summer of 2015, and I felt kind of blessed in that, you know, I was ramping intellectually in the space through 2014 and 2015, and so I wasn’t ever forced to be a Bitcoin maximalist. I always sort of came to the space with an open and rational mind or at least as rational as I could hope to be, and that’s what led me to explore the space as crypto assets, as opposed to Bitcoin, the single cryptocurrency.
Laura Shin:
Oh, interesting, whereas you feel like if you had learned about or gotten involved in Bitcoin earlier, then there would’ve been pressure to assume that Bitcoin was going to be the only crypto asset that would dominate? Is that what you’re saying?
Chris Burniske:
Somewhat, yeah. That’s a good synopsis. I’ve seen a number of friends from the industry, over the years, especially the ones…and had explicit conversations about them with this. I think Erik Voorhees has talked about it as well. You know if you got involved in, say, 2011, there were altcoins coming to market. I believe end of that year is when Litecoin launched, but you know there wasn’t all that much innovation. It was a lot of copy and paste coins, and Bitcoin maximalism was born out of that, right, and with merit.
Bitcoin was the main community with a lot of innovation going on, and there were things going on around it, but Bitcoin was the only one at that time worth paying attention to, and so if those blinders got put on at that time, for some people, they’re still working to take those blinders off, and so that was just…I got lucky with sort of coming in, in what I would consider to be the second wave, not the first wave, and now we’re in the third wave.
Laura Shin:
And when you were at ARK, I wrote about this paper that you coauthored with Adam White. That’s basically why I had you guys on the podcast that time, and you said that Bitcoin represented a new asset class. How did you come to that conclusion?
Chris Burniske:
Yeah, and that’s another example, actually, of a paper that drew a fair amount of negative reactions, although people did like it a lot, as well. So, the way we approached it tried to be as academic as possible and just let the numbers and the graphs speak for themselves. So, I read as much of the academic literature as I could, along with Adam White from GDAX and just to get a basis for how is an asset class defined, because it’s a classically fuzzy definition, and so working off of some prior work, for example, from Robert Greer, who wrote this paper, What is an Asset Class Anyway, we developed a bit more of a robust framework and really boiled it down to four main areas to look at.
First is the asset class needs to be sufficiently investable to be considered an asset class, and so this is where we looked at, you know, daily trading volumes. You know at that time, Bitcoin was trading in the range of billions of dollars daily, so, you know, you’re starting to see sufficient liquidity in those markets, and so that was just really checking a box. The next three where were it gets really interesting in terms of differentiating crypto assets from other traditional asset classes, and so that included an investigation of the political economic profile. So, that mainly includes the supply schedule. So, this is where crypto assets are extremely different in how the supply is mathematically metered from our traditional asset classes, where it’s really based on the whims of the human mind.
The next one is basis of value, and so that’s looking at, as we’ll get into later, how are these things valued, and then use cases, and again, use cases, this is where Bitcoin starts to get very interesting as a currency, so a means of exchange, store of value, unit of account, but also a technology, right, whose use cases can go beyond what you would classically consider a currency to be. Then there were things…the other two were looking at correlations. So, how does Bitcoin play in the market compared to the other assets, and this is where we found there’s near zero correlation of returns to bonds, equities, real estate, gold, you name it, which is a pretty amazing feature, and that shows…
Laura Shin:
Yeah, but I wonder if that will hold.
Chris Burniske:
Well, so that’s a great point. Right now, I think it indicates that this is an emerging asset class, right, so there’s not that much overlap between crypto asset investors and traditional capital market investors, but as that overlap increases, you know, I think you will see an increasing negative correlation of Bitcoin with most of your traditional asset classes. That’s because people use it as risk-off hedge, and what was fascinating about this study in early 2016 was there was zero correlation. It just basically meant, you know, they’re totally separate. The last thing, and people can find the paper online if they search for it, was just looking at the risk/reward profile, so absolute returns, volatility, which sums up in the Sharpe ratio, which are adjusting your returns per the risk taken.
Laura Shin:
Yeah, and I wrote about this at the time and from reading your book can actually see that some of these ideas even informed the book, but to move on to kind of like…or to go back to what you were saying about your career, so, you left ARK somewhat recently. Why, and how did you decide what to do next?
Chris Burniske:
So, I had been at ARK for three years and you know developed ARK’s crypto practice and really pounded the table within the firm on this is something of strategic importance, and I explored different business development opportunities at ARK. It was actually a large part of what my last year and a half was comprised of, because as an analyst, you know, there wasn’t that much that I could cover in the crypto asset realm that would be suitable for ARK as an investment, right? There’s really only a handful of things. So, I had to just find myself from a business development perspective and did a lot of work with different traditional infrastructure providers and regulators, and it is important work but a very slow-moving process.
And so I ultimately decided that if I wanted to get direct, fast-moving, in the weeds exposure to the crypto asset ecosystem, I would probably have to leave ARK, not because ARK lacks in innovation by any means. It’s one of the most innovative traditional financial service firms out there with this open-source research ecosystem and all that, but now, you know, ARK is approaching two billion in assets. It’s a bigger firm. It manages ETFs and mutual funds and so on and so forth, and so Joel and I decided to make this leap to work directly with the developers that are making this ecosystem come to life.
Laura Shin:
And just out of curiosity, why the name Placeholder?
Chris Burniske:
Well, the simple answer is that our lawyers picked it because…
Laura Shin:
Wait, what?
Chris Burniske:
Because in the early days, we hadn’t settled upon a name, and so we were just putting Placeholder in brackets in all of our documents, and we found we kind of liked that. It was amusing, but as time went on and we thought about it more, there were things we really liked. You know as a venture firm, we come, we help the developers and entrepreneurs get off the ground, and then, you know, when our job is done, we no longer necessarily have to hold that asset, and at that point, we may transition out and pass the asset back to the utility holders, and at that point, we have just become a placeholder, right? We just take up a little space and time in the development of the community. So, you know, that’s one way to think of it. There are other ways, other ways to think of it. It’s a bit of a shrug at the naming establishment, I suppose, as well, a little bit like Lowercase Capital or whatever it may be.
Laura Shin:
Okay, and so obviously we want to get to the book, but why don’t you briefly describe what you guys are going to be doing at Placeholder?
Chris Burniske:
Well, as I said, we’re just a venture capital firm that specializes in decentralized information networks incentivized by a token.
Laura Shin:
Okay. All right. So, let’s get to the book now. How would you briefly describe the book for listeners?
Chris Burniske:
The book is…so I have a coauthor on it, Jack Tatar, and it’s our best attempt to put everything that we thought someone who’s curious about the space that may or may not have a strong financial background, putting everything that we would think that person would need to start to get involved in these markets, and you know the reason we decided to do a book is because information out there is so fragmented. You know you do a fantastic job, Laura, covering the space, but you know you’ve written, I don’t know, over a hundred articles, by now, I would imagine, on crypto, and they’re scattered around the web, and then there’s Reddit and Medium and Twitter and Telegram and all these things. We just wanted to aggregate all of that in a sort of…I call it 0 to 55. It’s not 0 to 60. I don’t know that I want someone going 60 miles an hour in this market after reading the book, but 55 seems like a reasonable ending.
Laura Shin:
So, let’s get into some of the nitty-gritty around how to valuate these assets. If someone comes to you and they are wondering, you know, how to figure out…you know what the value is and whether or not something is like underpriced or overpriced, what would you advise them?
Chris Burniske:
Well, first and foremost, I don’t give price targets or public investment advice, so I don’t build these models, for example, or share them with the community to have people say, okay, I should buy this right now because it’s underpriced. I more build them to understand what the levers to value are on a long-term basis, right, on a 10-year buy and hold basis.
Laura Shin:
And what are those levers?
Chris Burniske:
So, I can talk through the framework, if you’d like.
Laura Shin:
Yeah.
Chris Burniske:
Okay. So, the first foundational thing that’s important to set is the use of what’s called the equation of exchange, which is also referred to as MV=PQ, and within traditional monetarism MV=PQ is an equation to map the flow of money through an economy, and so just to dimension out the variables so that, you know, we can progress, M, as in Mary, is the monetary base, so the size of the monetary base necessary to support an economy. So, you take something like the US dollar, monetary base is around 4 trillion dollars. Bitcoin’s monetary base right now is around 75 billion dollars. V, so, M times V, V refers to velocity, and velocity is a bit of an abstract concept, but it refers to the number of times within a certain timeframe, most typically a year, that a currency will turn hands, right?
So, if I pass one bitcoin to you, Laura, that, in that year, has a velocity of one, and then if you pass it to, say, Joel, again, that, at that point, has changed hands twice and it has velocity of two, so on and so forth. So, the US dollar, you know, velocity has been in this 5 to 10 range. It’s come down a lot since the financial crisis, which is another conversation. Then on the other side of the equation, you have PQ, and PQ, the P refers to the average price of a basket of goods in an economy, and Q refers to the quantity of goods, and when you multiply P times Q, that is where you get GDP, where this is traditionally used, right, and so what that shows you is multiplying the monetary base by the number of times that the monetary base turns over in a year, so that’s MV equals the size of an economy in a year.
Now, how does this apply to crypto? It applies to each crypto network because we can think of each crypto network as actually being an economy that operates in relative isolation. There is, you know, increasing interoperability and flow of assets, but if we think of each protocol as an isolated economy, then we can actually use this equation to map the flow of the crypto asset to provision the digital good or service that this crypto economy, so to speak, provisions, and so are you with me there before I move forward?
Laura Shin:
Yeah. Yeah.
Chris Burniske:
Okay.
Laura Shin:
You’re explaining this very clearly.
Chris Burniske:
Okay. Great. I’ve been practicing, so I’m getting better at this over the years, but so that sets up, you know, sort of this baseline theory. When I approach value in a different crypto asset, I always start with the supply schedule, and that is to basically look at, okay, how many units of this crypto asset are going to be issued each year, and what is the total amount that has been issued over time? And so the reason I do that is I need to know…in finance, it’s typically referred to as the float, what number of these assets are in the float and available for use within this economy, and so if I take something, you know, that say has had a hundred million tokens issued, you then have a hundred million out there, but I need to then take into account the percentage of those assets that are just being hodled, right, just held and not moving at all, because those have a velocity of zero in a year.
So, they’re actually pulled…although they’ve been issued, they’ve been pulled out of the float, and then there are other instances where you pull assets out of the float for things like bonding, so with proof of stake, or you look at how Filecoin may work and a lot of these other systems. They will require some of the nodes to bond a certain percentage of the assets to be one of the providers in the network. So, you know, in the work I did with Coinbase, for example, looking at their user base, roughly 60 percent of their user base, I think, in 2016, approached Bitcoin purely as a store of value, which means it had a velocity of zero and they just held it, which means, you know, only 40 percent of the Bitcoin really was being used that was in the float, and that’s a really simplistic example but just to give context.
So, once I have the total amount of tokens that are in the float, I then, you know, have an idea of, okay, these are the number of tokens that are going to be used in this MV=PQ equation, which then takes me to figuring out, okay, how is this crypto economy functioning, right, and that requires me to look at the price of the good or service being provisioned and the quantity of the good and service being provisioned. So, to give a very practical example, we can use Filecoin. I can figure out, you know, the price per gigabyte of file stored that will be charged by the Filecoin network, and I do that using assumptions, right, looking at what Storj is charging or Sia or these other existing crypto file-storage networks. I need to assume a cost decline, right, because these are deflationary technologies, and each year the cost to store files will decrease. So, that’s the P side, and I draw that out each year, you know, into infinity if I want.
Then I need to figure out the quantity side, the Q, and I do that by looking at the total addressable storage market, so how many gigabytes of files are stored out there, what percentage of that would be suitable to be stored by Filecoin, and then I need to layer, within that, an adoption curve, an S-curve based on a number of variables like when the network will launch, how quickly it will be adopted, and basically the steepness of the S-curve. Is it going to be really steep, is it going to be this more gradual takeover, and what that allows me to do is to say, okay, I think that Filecoin will take this percentage of the storage market and therefore store this number of gigabytes. So, I if I have Filecoin storing X number of gigabytes in a year and I multiply that by the dollar per gigabyte charged by the Filecoin network to store files, then I get the dollar value of that economy in a year, right, the transactional volume of that PQ necessary to support that economy.
Now, if we go back to this equation of MV=PQ, I only at that point have PQ. If I want to solve for the necessary size of the monetary base, I need to divide PQ by V, right? So, I have M=PQ/V, and that requires me to put in an assumption around what the velocity is, and that’s a whole other conversation. We can maybe come back to that in a second, but let’s say I have the Filecoin economy, you know, supporting 20 billion dollars’ worth of annual transaction volume to store files, and it has a velocity of, say, 5. I divide that 20 billion by 5, and I would say Filecoin would need to store 4 billion in order to meet that, that demand. That is how I’d back out the monetary base necessary, and then there’s a last step where I have to look at the monetary base and divide that monetary base by the number of tokens in the float to get the utility value per token in the float each year.
Laura Shin:
Okay. Wow. I love this. I have a whole bunch of questions, actually, about what you just said, but before we do that, let’s do our sponsor break.
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I’m talking with Chris Burniske of Placeholder Ventures and author of the new book Cryptoassets. So, some of the stuff I wanted to ask you about was around some of the assumptions you mentioned, like the percentage of the market that Filecoin might take or the steepness of the adoption curve and the velocity. How do you make those assumptions, and I’m assuming maybe you do a range of them to come up with kind of like a range of reasonable prices, or how does that part work?
Chris Burniske:
Yes. So, you can definitely do scenario testing, right, where I try different inputs and I look at how all of that plays out. I think something that may be helpful for your listeners is the crypto asset valuations piece that I published on Medium, where, actually it’s one of the longer Medium posts I’ve posted, I walk through this whole process in detail, because we didn’t even get to the sort of discounting future values back to the present. In terms of, you know, these inputs, say take velocity, velocity is one of the hardest ones, and this is why it’s very explicitly an assumption in my model, right, and there’s that famous quote, right, you assume something and you make an ass out of you and me, and so you have to be careful and explicitly understand that these are assumptions.
So, with velocity, if we look at Bitcoin historically, you know, I think in 2016, the velocity was around 6, and the way to calculate that for Bitcoin is let’s just say, you know, roughly a billion dollars in transaction volume a day, so that means 360 billion dollars of transaction volume in a year, and let’s say, so, that is PQ, right, and then let’s say the monetary base has been roughly 60 billion, right? So, then to solve for velocity, velocity now being PQ/M, I divide that 360 billion in annual transaction volume by a 60 billion dollar network value, and I get a velocity of 6, right, and basically what that means is the monetary base in aggregate had to turn over six times in order to facilitate that transactional demand.
Now, the tricky thing here is, as I talked about with the supply at the start, not all of the Bitcoin that had been issued are currently in circulation, or currently being used is maybe a better way to think about it, or currently being exchanged is more precise. So, for example, if we take this roughly 60 percent that is just being held, and I would posit that it’s actually higher, that has a velocity of zero, right, and so then I actually need to look at, well, what is the velocity of the stuff that’s actually being used? And so I if I take this 40 percent that’s being used as a means of exchange, right, it turns out that 40 percent needs to have a velocity of 15 in order for Bitcoin in aggregate, all of its units, to have a velocity of 6. I can walk through that math. It’s just a weighted average, but it’s the…
Laura Shin:
Right. No. That makes sense.
Chris Burniske:
Yeah, the point being that there’s a big difference with these assets between the aggregate velocity of all of the use cases of the crypto asset versus the means of exchange velocity, and for Bitcoin, I would argue that, you know, this 15 number, which is higher than traditional fiat currencies, or most of them, makes sense, but it’ll probably go even higher, and it wouldn’t surprise me if many crypto assets get velocities that go high into the double digits or even into the triple digits, and that can actually…it’s a bit counterintuitive, but that can actually erode the necessary value, the necessary network value or monetary base that that crypto asset needs to provision an economy.
Laura Shin:
Right. So, wow, I have so many questions, but one thing about what you just said is why do you think that the velocities will go higher? Is it just because the technology is so much faster than moving money via the traditional banking services, the traditional banking infrastructure?
Chris Burniske:
Yes. If you think about, you know, what are things that pull down velocity, a lot of…it’s friction, right? Friction is what pulls down velocity, even just if we’re thinking about it from physics, right, from first principles, what’s going to slow something down, decrease the velocity, it’s if there’s friction, and so friction with traditional assets, like if we think about, say, gold, right? That has a very high friction because I’m not going to, you know, lug around my gold bar and give it to someone else, and with fiat currency, that friction has been ameliorated, but there’s still a fair amount of friction to the physical instantiation of fiat currency, even though lots of it is digital now. With crypto assets, this is our first digital-native asset class, right? There is no physical representation of it, and so that actually decreases the friction necessary to move it and therefore I would posit will increase the velocity. Now, I think that…
Laura Shin:
Yeah, this reminds me of that somewhat famous scene in Nathaniel Popper’s book, Digital Gold, where Wences Casares introduces a whole bunch of other Silicon Valley types to Bitcoin, and they’re amazed as they watch…and it was…I forget what the amount…do you remember the amount? It was some huge sum of money.
Chris Burniske:
It was a big amount, yeah.
Laura Shin:
Yeah, like 250 thousand dollars or something that they basically passed the Bitcoin around to each other’s, you know, I don’t know what accounts he opened…I don’t remember the details, but you know if you were to do that with a traditional banking system, it would be, what, at least, I don’t know, 1 or 2 days for each person, and depending on if we’re in different countries, it could even be like a week between each individual person. So, you know, to pass it around five people would take like at minimum, you know, five days but probably longer or potentially up to five weeks if we’re all in different countries, so.
Chris Burniske:
Right, and so this is where it’s really important, you know? Velocity has kind of been a somewhat neglected concept within monetarism. I’ve been finding with the different traditional macro economists I talk with that it’s a bit of a polarizing topic. It’s really interesting, but this idea of these crypto assets will have hybrid velocities composed of, you know, the percentage of the asset that is a store of value is really important to pulling down the hybrid or the aggregate velocity, right, because those things have a velocity of zero, versus, you know, maybe only 20 percent of the crypto asset will actually be in the float, and it could have a super high velocity, right, say maybe 50 or 100, but so long as enough of the crypto asset is being held by the hodlers and the bonders or the stakers, you know, and they’re holding…the hodlers are holding based on expectation of increased utility of value in the future.
So long as there’s this equilibrium, which is very nuanced, then there could still be significant net worth value, but if the entire asset base is just, you know, whipping around and being used within this digital economy, you could make an argument for some of these protocols supporting, you know, hundreds of billions of dollars in economic activity but actually storing very little, because you can just be recycling the same unit over and over and over in the exchange for the good or service provided by the protocol. So, it’s just an important thing. I’m actually doing research with a couple of professors, Steve McKeon, who’s been ramping within crypto and writes some great pieces on Medium, and Alessio Saretto on looking at, you know, trying to do cross-sectional analysis and longitudinal analysis on the top hundred crypto assets to see, you know, are there patterns falling out about these velocities because it’s such a new space?
Laura Shin:
That’s really interesting. So, one thing I wanted to flag for listeners just because this is an expression we often see written but maybe not heard, Chris keeps saying hodlers, which is from…I think it was originally a typo, right, where someone wrote, like, you should hold, but they spelled it hodl? Isn’t that where that…?
Chris Burniske:
Yeah. It’s a hilarious sort of piece of Bitcoin history from Bitcoin Talk, where this guy got caught…I forget which down market he got caught in, but if you search like hodl Bitcoin Talk or where does hodl come from, it’ll show up, and he’s clearly drunk, he’s clearly infuriated that he bought at the top and all these other traders are making money, and he’s like I’m not a trader, I’m just going to hodl, and he’s just like, you know, clearly just pounding at the keyboard with a fifth of vodka or something at his side.
Laura Shin:
Okay. All right. So, I just, yeah, because in case you didn’t catch what he was saying, that’s what he was saying. So, I think what’s really interesting about what you’re saying about velocity here is that unless a cryptocurrency has some mechanism built in to kind of incentivize people to want to hold or hodl, the asset then, the velocity could potentially bring the value of these crypto assets down? Is that correct?
Chris Burniske:
Yes, that’s a good summation.
Laura Shin:
Okay. Okay.
Chris Burniske:
Yeah.
Laura Shin:
And do you see a lot of crypto economic systems building in something that will prevent that from happening?
Chris Burniske:
Increasingly, increasingly, so there’s a few different baskets of people, right, that could have a…let’s call them zero velocity folks. There’s the hodlers, and that is really just based on an expectation that this crypto asset will have increased utility value in the future over now, and therefore, you know, I am better…this is a good store of value, right, but then there are, you know, with proof-of-stake systems, which we’re already seeing more and more of, and depending on where Ethereum goes, we could have a massive sort of switch into proof of stake, those, the asset holders in that case become the new miners of sorts, right, and they actually have to bond their asset in order to become part of the consensus process, or you have some teams requiring staking or bonding more for reputational purposes, right?
I mean proof of stake, it is kind of a reputational purpose, but more to avoid Sybil attacks. So, you know, if you look at what Dash has done, they require you, if you’re going to be a master node, to stake…I think it’s a thousand Dash, and that’s just to avoid people who are mal-intentioned from becoming part of that network. So, I think we’re going to see an increasing number of teams doing this, and you know in the work Joel and I do with different developers, crypto economics is top of mind for us, especially because a lot of these teams are amazing engineers, and you can only sit there and look at them in awe, but not many of them want to spend all that much time with the crypto economics or even know, necessarily, where to begin. There’s a lot of indexing off of sort of what prior supply schedules have been, even though prior supply schedules of crypto assets have largely been experimental, and so that’s, you know, something where we work with teams, and we’re seeing a lot of traction and interest.
Laura Shin:
Yeah, and increasingly thinking that the crypto economics of any system are going to be crucial to whether or not it survives, because, you know, these are basically little economies that you’re creating, and you’re trying to incentivize the different actors in different ways, and if you don’t get it right, it’s not going to take off. I mean, granted, like it’s code. You can change it, but you know there is a benefit, I think, to getting it right early. I actually want to jump back to what you mentioned earlier about discounting because I do think that that’s also a super, super tricky part of kind of the different assumptions that you make. So, can you describe a little bit what that is and how you do it?
Chris Burniske:
Yes. Discounting, again, coming from the theory of finance, is this basic idea that a dollar today is worth more than a dollar a year from now, because I could take…if someone were to give me a dollar today, I could invest it, maybe get a five percent rate of return, and so in a year I would have a dollar and five cents. So, either give me a dollar today or a dollar and five cents in a year, but don’t give me a dollar in a year because that’s a bad deal, and so what I need to do is if someone were to try and give me a dollar in a year, I would divide that dollar by 1.05 because that’s potentially the interest rate I could get, which would mean that dollar in a year is worth 95 cents today, and so this is widely used within the pricing of assets because markets don’t price assets based on their current utility but actually the expectation of future utility, and the way that shows up with the pricing of stocks is, you know, the classic pricing mechanism within stocks is called the DCF, discounted cash flow model, and it discounts back future cash flows, in aggregate, to the present to say, you know, what is all of this worth?
And so I do a very similar thing with crypto assets, although the important thing with crypto assets is these things are not companies and do not have cash flows. So, instead, it is, you know having walked through this economy, what is going to be the size of the economy in the future, what is going to be the velocity, and therefore what is the necessary monetary base necessary to support that economy, and that gives me the net worth value, right, and then I divide that monetary base by the number of tokens that are in the float to get the current utility value each year.
So, maybe I have a current utility value in 2017 of 25 cents, right, or something like that, but then in the future, it is, say, 2025, there will be a different current utility value, right, and so I need to take that future current utility value or future utility value and discount it back to the present to get an idea of, okay, if someone were to offer to give me that token at that price in the future versus now, what would it need to be worth now for that to make it a good investment? And it’s going to be worth less, right, because I have to discount it back, and you know I’m using discount rates of 30 to 50 percent, which is extremely high.
You know you think of traditional equities, you’re using discount rates for high-growth equities in the 10 to 15 percent range, and again, that is to represent the risk inherent to holding this asset because I need to be compensated for the risk I’m taking as an investor. So, now this is all somewhat abstract. I’m sure there are some people who are getting frustrated as they listen to me, so the Medium post on crypto asset valuations really walks through all of this in detail.
Laura Shin:
Yeah, and you do also mention it in your book, which I do want to just plug for a second to say that I do think it is like a really good primer on just a lot of…I mean it goes into…I mean it’s just such a range of things. You know it talks about kind of like the history of other assets and how they also began maybe in a speculative fervor and then how they became more established. It talks about kind of even more technical things in crypto assets, like mining, but it has a lot of this kind of like more financial and substantive analysis, which is why I wanted to bring you on the show. I really find the way you think about these things really interesting. Let’s switch gears to…
Chris Burniske:
Really quick, Laura.
Laura Shin:
Oh, yeah.
Chris Burniske:
Because I super appreciate you taking the time to plug my own book, and McGraw-Hill would thank you because it’s something I need to get better at, for sure, but just for your readers, if they’re wondering, hey, is this book a good fit for me or not, as you mentioned, you know, there’s these three sections, right? There’s a what section, what are these things, right, to place crypto in the context of what we have out there, give some basics about Bitcoin and blockchain technology, cover the phenomenon of blockchain not Bitcoin, the history and taxonomy of different crypto assets.
I then launch into the why, right, so why does this stuff matter, why does portfolio management matter, how does Bitcoin perform in a portfolio, get into why these things aren’t Ponzi schemes, although, you know, exploring a lot of the history of financial speculation, and then the last section is how, so, you know, very practical stuff, how do you value these things, how do you choose your wallet, how do you choose your exchange, and again that was just a what, why, and how to help people, you know, whether they’re a millennial in their mid-20s who knows they need to start investing but don’t really know where to begin or whether they’re a financial services professional in their mid-40s, early 50s, late 50s, 70s, I don’t care, but that are interested in learning about crypto assets and have a financial background. It works for sort of the whole gamut.
Laura Shin:
Yes, I definitely agree. It’s funny because actually when I was reading it, I was like, oh, I’ve read about a lot of this stuff, maybe not some of the more, like, the stuff that we’ve actually talked about in this podcast, like how to valuate these crypto assets, but a lot of this, I was like, oh, if I had pulled together my articles into a book, then…
Chris Burniske:
Well, you’ve known me for a few years now, so I’ve shared all of my secrets with you.
Laura Shin:
Oh, I know. Well, in case listeners don’t know, in case you only listen to my podcasts but don’t read my articles, Chris is easily one of the most-quoted people in my stories because he’s one of the smartest people I talk to in crypto. So, anyway, well, so I do want to switch gears because you did touch on a Bitcoin ETF in your book, and since you do come from traditional financial services, I wanted to hear your take on how you think this revolution will play out, in particular crypto assets, how you think that will play out in traditional financial services, like when we’ll start to see things like a Bitcoin ETF or you know however else you think it will play out.
Chris Burniske:
Well, I would say it’s only a matter of time until we see more and more traditional vehicles that securitize Bitcoin and other crypto assets or provide this well-understood and easily recognizable wrapper to this new asset class, but you know in terms of how much time, I don’t know. It’s really hard, and you know that was part of my later time at ARK was realizing, you know, regulators get it, regulators understand, they’re there, but this is going to take years, and so if you look at the SEC’s rejection of the Winklevoss Bitcoin ETF in March of 2017, you know, they had clearly done their work on the space and were making the decision from an informed position, and they came down notably hard in terms of saying that they found Bitcoin too largely beyond regulated markets.
And so if you think about, you know, from the perspective of how the SEC approaches stocks, the SEC has good visibility into all of the stocks that are traded given, you know, all the infrastructure that has been built up and all of the reporting and all of that, but then you approach Bitcoin, and while there are a number of what I consider to be top-tier crypto asset exchanges, GDAX being a great example, that follow the letter of the law, there are also exchanges and markets where, you know, there’s not as much clarity, right, and so I can see for the SEC there’s some un-comfort there, and if they want full transparency into all of the Bitcoin that is traded globally to avoid insider trading and that kind of stuff or to spot it out, that will be harder.
There’s a case to be made there in terms of, you know, we don’t see all of the gold that’s traded globally, but we still have gold ETFs. So, I think that, you know, the most tangible thing I can say is derivatives first, and you know we’ve already seen a fair amount of activity on the derivatives front in terms of swaps and futures, and that’s important, and the CFTC in the US has been kind of the regulator that’s been early on wanting to work with the crypto realm, and then, you know, those instruments are important for institutional investors because they set up well-known infrastructures, and traditional financial institutions know who their counter-party is, and it just checks off a bunch of boxes for the risk committees, and that will get these bigger firms to play more in the markets, and then, you know, I think it’s a progression over time.
Some people don’t know this, but gold ETFs, I don’t think GLD, the biggest gold ETF, came to market until late 2003, maybe early 2004. So, that hasn’t even been around for 10 years or just over 10 years, and gold is an asset class that we’ve had for thousands of years. So, you know, for me, there’s no rush, right? Like, it’s going to happen eventually. I’m not overly fixated. It’s not my job anymore either. I’m not overly fixated on when these things will be securitized, but it’s going to happen because this is a new asset class, and the inertia is inevitable.
Laura Shin:
Well, so something that I’ve been thinking about is that the rate of innovation that I feel like I’m seeing on the public blockchains is happening so quickly, and when I read stories or hear people like Jamie Dimon making the comments that he made, and I realize just sort of how out of touch he is and how little he understands about what’s going on, and you even mention it in your book, you said that distributed-ledger technology, which is the phrase that people are using to describe bringing Blockchain to traditional financial services to make their systems more efficient but not really fundamentally change them, you called that a Band-Aid on financial services to protect them from disruption.
So, I’m just curious, like, how quickly do you think the disruption of financial services will happen, and like, you know, in terms of what we were saying about the Bitcoin ETF, sometimes I wonder, oh, could we sort of see people not caring at a certain point about a Bitcoin ETF because the public blockchains have taken off in such a way where it maybe doesn’t even matter anymore?
Chris Burniske:
So, such a fascinating question, Laura, and I feel like we could talk about that for a podcast in and of itself. So, to start with the ending bit about a Bitcoin ETF, and maybe people won’t care, and then we’ll come back to DLT, you know, it’s interesting. While I think a Bitcoin ETF would be an important moment for the space, it’s a bit of a bastardization of Bitcoin in the sense that you’re taking this beautiful, really efficient new asset class that doesn’t need to be securitized, right, to…it’s almost redundant in a way, right, to custody it and to securely transmit it around the world. You’re creating this extra layer, unnecessary layer, so that it fits. It becomes a recognizable puzzle piece that fits within what the traditional financial services will accept.
It’s kind of like, you know, within biology where different proteins need to fit together, and right now Bitcoin’s kind of this weird virus, amoeba, whatever, and financial services doesn’t quite know how to let it attach, and an ETF will let it better attach. Now, in terms of…but longer term, you know, okay, maybe much of the financial services as we know it will be commoditized, and I don’t think it goes away. I think, you know, the middleman gets commoditized and squashed, and therefore maybe ETFs are less important than, you know, just tokenized baskets of crypto assets, or whatever it may be, but let’s jump to the idea of distributed ledger technology and Jamie and sort of that longer battle that you and I have witnessed over the last few years.
You know I alluded to it at the start of the podcast, but 2014 and 2015 was rough, right? People were saying Bitcoin’s not necessary, Bitcoin’s going to zero, blockchain technology is where it’s at, and I read about this in the book, you know, October 2015, Blythe Masters comes out on the cover of Bloomberg Magazine with blockchain stamped across her body. The Economist publishes a cover article called The Trust Machine, and there’s all that kind of emphasis on blockchain, and then the term distributed-ledger technology started getting used to dissociate, right, from Bitcoin and Bitcoin’s blockchain and that confusion and sort of what the financial services considered to be this quickly dying and dirty past.
And now, you know, you look into 2016, there was still a lot of distributed-ledger technology hype, and Ethereum started to catch people’s attention, certainly, given its meteoric rise in 2016, but now 2017, things have swung back to the public blockchains and the crypto assets that are necessary to incentivize their functioning, and that’s really exciting, and it actually fits perfectly, and Joel and I have been saying this for a while now, this whole progression fits what we classically see with disruptive technologies and innovator’s dilemma, right, where a new, open, highly disruptive technology comes out, generates a lot of interest but disdain from the incumbents.
The incumbents then say, okay, this may be kind of important, I’m going to take components of this technology, co-opt them, put them in my existing business models, but leave out all the components that I don’t like that commoditize my existing business model, and that was what DLT was, right? It was I will take out the asset and I will just use this cool new database technology. Then what happens as the incumbents are sort of playing within that smaller pool, the truly disruptive and almost always open version of the technology is gathering momentum, momentum, momentum, and then there’s this explosion out of nowhere, and it catches the incumbents off guard, and I would say that’s what 2017 is shaping up to be.
I was at a Credit Suisse conference speaking yesterday, and it was filled with suits and ties, and everyone, it was a crypto conference. It wasn’t a DLT conference. It wasn’t a blockchain conference. It was a crypto conference, and so I think now people are waking up to, oh my god, these are open, permissionless, bottom-up, innovation networks. Classically, that always wins out over the private networks. Maybe we were wrong about DLT, and you know that’s a point that I make in the book that, you know, DLT, sure, it’s important, it has a role to play, it will make things better, faster, cheaper, but over the long term it will pale in comparison to the size of innovation and value creation within these public blockchain networks.
Laura Shin:
Yeah. I agree. Okay, well, this has been such a fascinating discussion. Thank you, so much, for coming on the show. How can people get in touch with you?
Chris Burniske:
The best way is Twitter. I am constantly a recovering Twitter addict, and I can be found @CBurniske, so my just first and then last name, and the book, there’s a website for it, just very simply bitconandbeyond.com, where Jack and I will be listing upcoming speaking events and different things that we publish, and maybe I’ll be coming to a conference near you sometime. Who knows?
Laura Shin:
Okay. Great. Well, thanks, again, for coming on the show.
Chris Burniske:
Thanks for having me, Laura. It’s always fun.
Laura Shin:
And thanks, so much, for joining today’s episode with Chris Burniske of Placeholder Ventures. To learn more about him and to find previous episodes of the show with other innovators in the blockchain and crypto space, check out my Forbes page, Forbes.com/sites/LauraShin. Also be sure to follow me on Twitter, @LauraShin. New episodes of Unchained come out every other Tuesday. If you haven’t already, rate, review, and subscribe to Unchained on iTunes or wherever you get your podcasts. If you liked this episode, share it with your friends on Facebook, Twitter, or LinkedIn. Unchained is produced by me, Laura Shin, with help from Elain Zelby and Fractal Recording. Thanks for listening.
