Dean Curnutt of the Alpha Exchange explores topics and financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry. Here is the transcript of their episode featuring GSR co-founder and Head of Trading, Rich Rosenblum.
Dean: When it comes to obvious asset class similarities, crypto and crude might seem to have little in common. But for rich Rosenbloom, there are linkages between them upon closer inspection, seeing similarities in the diversifying characteristics of both assets in broad portfolios. Rich also notes the tendency for digital assets in crude to experience phases of investment and then value extraction from that investment. The net result is volatility.
On this episode of the Alpha Exchange, it was a pleasure to solicit the reports of rich, the former Global Head of oil derivatives at Goldman Sachs and for the last seven years, the co-founder and head of trading at GSR markets focused on delivering trading and investment products solutions to the crypto space.
Our conversation explores the financial attributes of Bitcoin, its correlation to risk markets, its periods of strong price momentum, and how it may perform during the chaos that investors are especially worried about right now. We also discussed the expanding market for options on Bitcoin, and the manner in which the vol surface is priced both across strike and time. The increasing degree of liquidity in this market provides new opportunities to gain exposure to both the upside and downside movements in the largest cryptocurrency.
Rich, it’s great to reconnect. Thanks for coming on the podcast with us today.
Richard: Likewise, thanks so much for having me.
Dean: Well, we’re gonna have a lot to talk about in the realm of Bitcoin, this asset on which your firm is extremely focused on and the kind of leading asset in the cryptocurrency space. As we get our conversation underway, why don’t you tell us a little bit about your current venture, how you got started in the crypto space and what uniquely is GSR looking to bring to the asset class.
Richard: So we got started towards the end of 2013. And I think we were the first institutional market maker in the space. So when we got started, unlike in traditional assets, where you had the floor and you had voice trading, in crypto it really skipped that since on its first day of trading a dozen years ago, it was already electronic trading.
So at GSR, we built an institutional platform for algo trading, and did contracted market making initially on behalf of issuers, groups that create coins and tokens. And then a few years in, doing contracted market making on behalf of exchanges, and then providing one side of liquidity for other stakeholders such as miners, and custody providers. And so we’ve always been very much a crypto native trading services provider.
But as the space has grown, we’ve grown, we’ve had some touch points on traditional finance, and started more of a venture arm. But I think our mantra has been that we’re looking to reduce the friction between capital and innovation. So unlike some other groups that are trying to create investment products, or focus purely on liquidity, we really want to look at all different types of ways to bridge that gap between capital and innovation.
Dean: So an asset class really becomes important as there’s players on both sides of it. And, of course, and we’ll talk more about this, but in your days on the energy derivatives desk, there’s of course, the original kind of demander of liquidity, perhaps it’s a government looking to hedge its exposure to oil on a going forward basis. And then you’ve got speculators on the other side.
Just big picture, if you were to sort of help us think about the evolution of the asset class from something that was a really cool thing known by some people in the early days and now clearly has adoption rates increasing, and it gets a lot of press. Folks like me watch it from the outside and you see the spirals up and down in price. What’s been the evolution from a liquidity standpoint over the past couple of years? How would you bring that to life for us?
Richard: It’s easy to make comparisons to oil since that’s where I spent the bulk of my career. I’ve spent more time trading oil even though it’s been seven years in crypto. So in terms of the types of players, crude oil went from being a North American producer-driven market, the large multinational oil companies, they had more oil in the ground and more hedging that they could do that would just dwarf the entire market.
So the hedging that they would do 5% to 20% of their yearly production was what moved the market. And being on the sell side, if you knew where all the producers were selling, or when they’re buying puts, it makes you a good prop trader, since you’re seeing all the flows.
In crypto, it’s a very different genesis having it being a retail marketplace from day one. And even though traditional institutions are coming in, more institutions are crypto institutions like Coinbase and Bitmain the main large exchanges and mining manufacturers. So it’s been a different evolution.
But I’d say in the past two years, the most interesting development is that, as opposed to it being all these disjointed futures and spot exchanges coming together and getting more clarity on where value is, it’s also been the origination of the derivatives market, both futures and especially options in the past year, have exploded.
And even though option liquidity is light on a relative basis to linear liquidity, the growth and options and the number of participants, open interest, the length with which you can trade out an option in, time has been a radical change that I think might not have existed in any other marketplace in history since, I think there’s so many people who have wanted to trade options. And once that initial saturation is there, whether it’s groups looking to hedge or speculate that initial saturation is there, they’re able to jump in and start trading.
Plus, most people are aware of the Robin Hood effect. I think that there’s been a very nice entry in 2020 for retail people to be trading options. And in addition to trading Tesla and Robin Hood, retail has come in and I think that we’ll continue to trade Bitcoin options.
Dean: You said that you got your start in the space in and around 2013. I haven’t done a lot of reading on Bitcoin. But I did pick up that book, Bitcoin Billionaires by Ben Mezrich. And one of the descriptions in that is that a big ramp up period for Bitcoin early days was around March of 2013.
After there was this controversy with respect to Cyprus banks, where depositors were effectively crammed down, are there big events that for your career, as you look at the space have been meaningful in terms of whether it’s advancement from an adoption standpoint, or where liquidity just took a leg higher and became kind of self reinforcing? To improve the asset class dynamics? As you look back on your seven years in the space, what are the types of things that stand out to you in terms of the asset class?
Richard: I think that speaking two things that are very specific to Bitcoin, the first that comes to mind is the halving or halvening, unlike traditional commodities, you have a fixed amount of the digital commodity being produced every 10 minutes, every day. And that amount, cuts in half every few years.
So in May this year, you could time nearly to the second when this halving would occur. And what happens is that producers, their margins are being cut in half by that process. And the price to produce a Bitcoin went from roughly $4,500 to $9,000. So there isn’t a fundamental reason why that has to act as a floor in the same way that it would have been for oil producers, as their cost basis just doubled, but there has been some of the same impacts there.
So every few years when this halving occurs, there tends to be an explosive rise around that time. But there weren’t as many eyes on the market until this year. And this year’s a very interesting year, given what’s happened in the macro landscape. And given that there is the ability to buy options. So to some degree, it’s harder to have that explosive rally, when there’s a bit of large numbers, it’s easier to go from $20 million to $2 billion than it is from $200 billion to $2 trillion.
And also just that people had a lot of different risks they could take from a macro perspective, betting that this quirky thing happening in Bitcoin is going to make the price go up, you’d have to compare that to a lot of other great risks you could be taking in a market. And it wouldn’t necessarily be macro investors’ focus, unless a few of the main investors like Paul Tudor Jones, who decided to take a big stab at it for more macro reasons.
Dean: I remember reading about the having back several months ago, and it wasn’t entirely clear to me, I think I get it now. But would you mind just laying out exactly how this works? The degree to which this process is entirely predictable? It’s kind of scheduled and is there anything that you’d compare it to? does it occur in other digital assets as well?
Richard: There’s been various forks of Bitcoin and there’s other processes where there’s some type of forced mechanism on inflation, to limit the amount of growth and the amount of variety and speed with which people are iterating on these concepts. It’s extremely prolific, but to focus on Bitcoin, Bitcoin is very much the first and I think, because it’s been so impenetrable and been able to use it as a transfer of value with more uptime than the swift system or any one banks system, people hold a lot of respect for it.
And without getting too into the weeds, the processes, which you’re using your computer, which started off could be a cheap laptop in your basement to now, it requires a strong processor, which is built specifically for Bitcoin, mining or otherwise, you wouldn’t really be profitable is that the computer’s CPU is hunting for prime number amongst a very large number. And if your computer is the first to find this next set in numbers, then you would be rewarded with the next block. And so there’s only one block that’s available in each of these sets spans of time. And so if you’re rewarded that block, then you’ll derive the value from that next Bitcoin that’s being unlocked, or portion of the Bitcoin at this point, since it’s based on fractions of one.
And then, as opposed to this being a wild goose chase for mathematical people passionate about mathematics. This process is what secures the network and validates the next message that’s going to be appended onto the blockchain. So it’s a very different route than traditional finance, where you have a centralized mechanism for determining where value is where it should be transferred to. And it brings up this idea of decentralization, that, once you have all these people hunting for the next block, working in unison, you’re able to come to consensus without there being a central party required.
Dean: One of the things I was just looking at in terms of bitcoins volatility is that at least on a realized basis, it’s come down dramatically, we’ve seen periods where the vol has exploded, both for reasons that the asset is rising dramatically, and sometimes it’s falling dramatically.
But this period is just it’s a range bound period, and you’re getting realized vols in the 20s, and 30s, and 40s. So quite low, if you go back and maybe this is where we can pivot to talking a little bit about crude. If you look at the pandemic, of course, all asset volatilities literally exploded, Bitcoin, among them, the S&P, but crude had one of the most remarkable episodes, not exactly in March, but kind of an offshoot of the pandemic in terms of this meltdown in the front month, futures contracts and crude.
So let’s talk about that because I would love to get your take on that. Just given your tenure, overseeing crude oil trading at Goldman, for so many years. Big Picture. Is it something you ever imagined? Was it kind of in the cards or in the potential modeling scenarios where you’re at Goldman Sachs that front month futures could go to negative one, but negative 35, I think was just about the low print. What’s your take on the episode itself?
Richard: I think looking back 10 years ago, it definitely was a question that came up. And it would be yes, it’s theoretically possible. But crude, you can store it. And there’s all these different types of storage. It doesn’t have to be pipeline storage, or physical storage, you have the ability to put on ships or even in pickup trucks if you needed to.
So I think the view is that it’s unlikely to go negative in the same way that certain physical natural gas contracts would go negative because you pay someone so you don’t have to burn it out and half the cost to the environment. I think that it was a somewhat hotly debated issue. But I don’t think that many people would say that it would go negative. And I think a lot of the fundamental specialists today would say that, even though it’s a physical future, physical crude, never really traded negative,
Dean: Certainly a blip, but such a violent blip. And at such a price that I’d say for most was on the roughly unimaginable side, just in terms of how negative it got a lot of attribution is given to some of the ETFs that were created some of the retail following in ETFs, USO was doing a lot in terms of trying to rebalance, there was another ETF product out of China. I’m not sure if that’s something you followed closely. But I’m just very curious. Again, as you step back and you think about attribution, cause and effect. It’s such a big move. As you try to piece it all together. We’re in the midst of a huge demand shock and inability to kind of move things around. How do you kind of explain how it got to such a negative level? What’s at the top of your list in terms of the factors that matter?
Richard: I think that there’s a confluence of a variety of factors. I’m happy to go over some of them. But I’d say that you heard about peak crude oil, peak demand. And the bricks 10, 20 years ago, in the last 10, it has been more about peak shale. The ability to use technology to search for crude, to pull it out of the ground in North America, especially to create shale oil has really been a game changer and so that we knew where there was going to be increased production. And so the market has to grow in order to take out that incremental production. So coming into 2020, even before the virus, we needed some demand in order to take over that new supply that’s largely coming from North America.
But then obviously, as we all know, instead of growing, demand was starting to drop rapidly due to the lockdowns and as its still predominantly a transportation fuel, making everyone go inside, dropping both pedestrian driving, as well as military, as well as corporate is an absolute disaster on demand for oil.
And then we had an OPEC meeting start on the fifth and it went poorly since Russia and Saudi Arabia failed to come to an agreement. And I think it was that Russia felt it was impossible to defend $50 oil, and so wasn’t able to come to agreements with the Saudis at the meeting the market fell $5 as soon as the press conference concluded.
And then that weekend, Saudi Arabia lowered their differentials drastically. These are the official selling prices that they sell their native crudes against and signaled the beginning of a price war with Russia. So they simultaneously booked an armada of tankers and flooded the whole market with new exports. Oil prices opened $15 lower that Monday the ninth of March and in early April Saudi Arabia and Russia agreed to end their price war, and OPEC announced the historic 10 million barrels per day cut. And that’s that stage for a rally, the rally didn’t happen right away. The forward supply demand balances in Cushing were still expected to be beyond capacity, but sent WTI lower and was able to drag the rest of the complex down.
So those are the physical concepts at play. And then on the financial side, there’s clear discussion about it trading negative – $40 isn’t a little bit negative, that’s as much negative as we are positive today. And it spooked the market, but it’s a bit misleading. And I say that because negative prices didn’t really represent the physical reality at Cushing, or anywhere globally, it was more of a financial phenomenon.
And when prices went negative, on the penultimate, the second last day of trading, the financial open interest was exiting the contract. And on that last day of trading, physical players with tanks stepped in, and price settled at plus $10. So the weakness on that second to last day, I’d say the biggest smoking gun was the USO ETF, it was rolling 10s of thousands of lots waiting to the last minute, and then in a forced fashion they had to sell. And that combined with the negative gamma from calendar spread options, and probably some other speculators taking advantage of the situation caused a once in a lifetime negative collapse.
The FTC and CMEs has investigated since and USO has changed what they do, they now hold the risk and four to five contracts, and they roll earlier on and on a more discretionary more clandestine basis, it’s there’s not a website where you can see exactly where they’re holding, and when they have to get out.
In addition, we did see from the macro perspective, market correlation was going higher, which creates more risk in a portfolio. And so with correlation spiking and the portfolio’s of macro funds rising, if you have to get out of something, oil futures are highly liquid. So I think they were one of the first to get dumped. And same for Bitcoin. So it wasn’t as much about the long term fundamentals, and more about a short term deleveraging.
Dean: It’s a fascinating event, and one that if you step back and you look at the unexpected moves, the vol that was associated with the pandemic, a number of things really do stand out, S&P realized vol got to, I think over a five day period, we realized 175%, the vol in the bond market was beyond epic. It was a new all time high in the move index. But really what trumps those so to speak is the OVX – the oil, implied vol got to 350 or something like that, just unbelievable results.
And I keep thinking about just the settlement, at settlement when you’re trying to jam through too much at one point in time. That’s where effectively you’re going to get at least potentially some inability to pair off supply and demand, in the VIX market back in 2018 we had that blow up through this ETF called the XIV. And it just ate itself alive trying to re hedge in about 10 minutes trying to do more contracts than you could imagine in that period of time. And you can get them done. It’s just going to move the price dramatically. So fascinating, fascinating period. Thanks for sharing that perspective.
Let’s go back to Bitcoin and just maybe thinking about the characteristics of it. One of the things I was listening to, a podcast with Mike Novogratz and Bill Miller. And so Bill Miller is a famous value investor, but quite interested in Bitcoin. And he framed it in a way that I would frame it. And it seems like you’ve been thinking about it as well, which is, it’s got this right tail characteristic.
I remember, back in our economics class in college, there was this concept called a giffen good, the demand for it goes up as the price goes up. I’m not sure exactly that’s it, but it clearly has got this very strong momentum characteristic. I’d love to get your take on that. I know you’ve done some, a lot of thinking on it and some writing on it, how would you describe the behavior of Bitcoin and just how it interacts with maybe its credibility, and the demand for it?
Richard: In terms of the fundamentals for Bitcoin, we’ve all heard it liken to be a digital gold and that it’s immutable, there’s a fixed amount of Bitcoin that will ever be created. And same with there’s somewhat fixed amount of gold that we’re ever going to find.
So they both have scarcity. But I would say that, even though there’s discussions of gold bugs, that we should go back to the gold standard, or inflation is going to cause gold to go up and be size 1,000. It’s not as if gold is this evolving technology that is going to be adopted in a new way, it would be going backward in time and having people care more about gold jewelry, or passing on gold as a form of value.
I think that there’s similar concepts involved in Bitcoin, but in giving it a more technological wrapper, in addition to just the pure aspect of scarcity and having the ability to send it within seconds. And just the notion that you can build smart contracts on top of Bitcoin, you can change the technology that’s layered on top of Bitcoin and use it for different things.
I think it really creates the sense that, like you said, in the right tail, that if bitcoins in the hundreds of billions now, we don’t need to have it be the internet form of currency that everyone adopts. For it to go to a trillion, I think that we could have it be more quirky, crypto specific ways where you can use Bitcoin, whether it’s in eSports, or gaming, it doesn’t even really need the financial markets acceptance for it to continue going up.
But at the same time, when you have players such as Paul Tudor Jones that are willing to buy $100 million dollars worth of Bitcoin futures, and say it’s the fastest horse for inflation. I do think it provides some of the same benefits. If you’re worried about debasement, and you don’t know what currency to hold the dollar to be short the dollar against, it’s a nice piece to have in the puzzle.
And I think that it’s probably not going to be in the same way, gold never was 10% of large investment portfolios, increasingly getting to be in the right circles, the largest banks, the largest financial institutions, the largest sovereign wealth funds, that having a1% or 2%% seems reasonable. And I think due to the fact that it’s still such a small market, it wouldn’t be in the top 30 stocks in the S&P. So all you need is one of the right people to be convinced, and the asset could multiply. So I fully think that that right tail there is visible, whether it’s more acceptance from traditional financial markets, or just that a technology that finds acceptance from this parallel ecosystem of tech that continues to grow.
And I think that’s an important point to focus on for another minute that people that make their money in a certain asset class. I’ve seen it with Texas oil men, they tend to be comfortable keeping all their assets in the space and wanting to grow.
It’s a bit different in the crypto space, where we’ve had a number of billionaires minted within the case of months, rather than years or decades. And these are groups that instead of wanting to diversify, because they don’t believe in the space, they’re evangelizing to the point of like, sort of a situation where every penny, every hundreds of millions, they earn or grow, they invest back in the space, and it doesn’t mean to just buy more Bitcoin in leveraged fashion. They’re building new infrastructure. They’re coming up with new projects, incubating and investing in new projects. I think all of this is going to bring more focus and more money into the space.
Dean: Seems like some of this is about accessibility. It’s not like I can walk into CVS that easily and get Bitcoin. But I was reading that it was in July, the OCC gave the green light to banks to offer custodial services on crypto and Bitcoin. To what extent is the development of infrastructure important? And what’s the progress been on that front to make this a kind of everyday asset that I can access in easy fashion? What’s the progress there?
Richard: There’s been good progress since 2017. And the initial run up of the institutions are coming, I think, at that point, was mostly retail speculation. And it was clear that there wasn’t that on-ramp. But guys like Novogratz, and Barry Silbert’s grayscale, there’s been means without an ETF to have a regulated and trusted way to get into this space.
I think that it’s less about the infrastructure at this stage. It’s more about the newness and the taboo, that’s still associated with Bitcoin.
A few years ago, if you said you were going to invest might look like a bit of a weirdo. If you said, you’re going to get into the space and work full time, you would get even more of a strange look. But now the number of ex Goldman partners and traders that are working full time in the space, not just investing in the space but that are talking about it is unfathomable to me versus what it would have been a few years ago.
And I think that that taboo is shifting, but we still don’t have real money entering, the headlines I’ve seen about pensions or dominance that have come in, it’s more of that in the tens of millions. And that’s not really a real money ticket.
And so the infrastructure I think exists, but to have it be of the scale where someone could comfortably write a 100 million dollar ticket, not just for the futures, but to buy spot, I think that it’s more about having a bit more time pass so that the taboo starts to go away.
And being the first mover in an extremely institutional environment you often you’re seen as the pioneer who gets the air in your back, people are less likely in a large organization to be the first mover even though that’s where there’s going to be some of the most rewards, I think people are more looking to make sure that they have themselves covered and wait for a few others come in.
I think that’s the rationale behind why some of the banks are still at arm’s distance investing. But once we see JP Morgan, have a bank desk or Goldman, I am confident the rest will follow. So now that custody is allowed, even though we have custody offered by fidelity, custody offered by Bakkt which is owned by York Stock Exchange. I think that over the next two years, we’ll see more of these full name brands provide the services, we’ll see more of the largest institutions in the world, right there first tickets, and there’ll be a purchase process after that of the others following.
Dean: You mentioned adoption, and it probably still is underrepresented. I think that’s one of the bold cases I hear just in terms of the overall positioning that it doesn’t really have yet in the average institutional portfolio. Even though there’s some headway being made, it would seem to me that two things would matter, in addition to making it easy to access, and having less and less friction to get in and out. Vol and correlation, we talked a little bit about vol. And the fact that that vol is down by a substantial amount, versus let’s say 2017, which was a great vol event and market was rising so dramatically, but there was so much risk of buying it on the wrong day, just given how significant the moves were. So now you’ve settled into something that’s much more reasonable.
And then correlation, I was hoping you might share some of your thoughts on this. As I step back, and I look at its correlation to other things in the crypto space, that’s pretty high other crypto assets, it’s pretty correlated to gold, especially recently on the order of 50% or 60%. And sometimes correlated to the stock market, sometimes uncorrelated.
How would you kind of size all that up in terms of its characteristics? What is it related to and what does it represent to you in terms of correlation?
Richard: It’s a space and a product that’s in a state of transition, it’s no longer frontier tech, where you’re going to expect 100 or 1000x by investing in Bitcoin itself, it’s already gotten to be the size of a relatively large company. And so we are going to need a lot of things to take place for the price to multiply. I think multiplying one x two X is one thing, but it’s less of a VC investment. It’s more like you’re investing in the S&P.
But I’d say in terms of correlations, I saw a similar transition in oil that in early 2000s, oil was very much moving according to fundamentals, maybe not on a daily basis, but on a quarterly basis. If demand was higher than supply, the market would be going up. You could buy the forward market and have good confidence that you have someone running the balances accurately that you could continue adding to that position it was going against you. And now with good confidence that you’re going to be right.
Scroll forward to mid to late 2000s. And then people on the desk were actually looking at the morning numbers, the screen on Bloomberg, and it started to trade as more of a macro asset. So it followed the rest of the commodity complex and risk markets. And there’s a portfolio of risks that a large hedge fund managers are holding and they’re dumping risk, then oil is going down with it.
So I think we’ve seen similar with crypto, especially this year, where if groups are holding a basket of risks, and they’ve got equities, got bonds, and they’ve got a bit of Bitcoin in it. If correlation goes up, and the risks spike, they’ve got to cut down on the risk, that’s going to enforce Bitcoin dropping on the margin on a big move.
And then on the small moves, if you have market makers that are quoting the price of bitcoin, and they have to quote a more sizable trade, if they see that gold has drifted up a bit, they see that the S&P has drifted up a bit, they’re more likely to bid closer to mid market and offer above. So on the micro scale, minute to minute scale, I think it’s that market makers and speculators that are helping enforce recent correlations, even for reasons that are outside of fundamentals.
But I think that as far as the broader direction of Bitcoin, it’s got this hybrid personality of being both a commodity as well as a technology product. And if we do end up having a higher price, unlike a commodity that that would bring out less demand and more supply. With Bitcoin, we have a fixed supply. And then this higher price mean that we’re going to have less demand? I would actually argue the opposite that people see that as a validation. If we get to $20,000, they’ll think it’s a result of adoption, and we’re gonna have more demand coming in.
And I think that there’s also this retail mindset that tends to be more momentum driven, that what goes up is going to continue going up. And I think that’s what’s driven a lot of the popularity of Bitcoin over the past decade that it’s been this asset that’s been really mystifying people and its ability to always go up.
Dean: We talked a little bit about the volatility and of course, that figures prominently in the pricing of options. So my understanding of this and I’d love for you to fill in the options market is still nascent, but certainly made a lot of progress over the last couple of years. I’d love for you to describe the big picture when you step back and look at the kind of almost supply demand ecosystem of how volatility is traded. The interaction between overwriters or hedgers, how the market trades, are the people that are trading the volatility the Delta hedgers or are they generally long vol, short vol or does it really depend, give us a flavor for how this options market works in Bitcoin.
Richard: As you’d expect a few years ago, the options market was trade by appointment, and all call buyers. When you have an asset that can go up 10 X in a year, it’s going to have a monstrous outright vol level and a monster call skew.
But then as the market value has gone up, and vol has come down part has been from fundamental reasons that it’s harder to 10 x off of a higher base. But also what’s happened is that groups have stopped getting that parabolic rise, but they still want a return.
So we’ve seen overwrites both from miners that want to create some profit without having to sell. So selling some calls against their forward exposure against their current portfolios seems like a good trade and also right way risk. If the market skyrockets higher, and they’ve sold some of their portfolio prematurely. It’s still happy days.
And then similarly, you have some funds in the space, they’re sitting on bitcoin. And even what we’ve described as a low vol of 50%. That’s still a relatively high vol compared to most other asset classes.
So if you can generate a 20% return by sitting on Bitcoin and selling out of the money calls, it’s pretty enticing. So I think that that’s been the dominant flow of 2020. That, even though there’s fundamental reasons why the market should be extremely volatile, we’re not that far out of the woods from COVID or even right now.
We have an epic election coming up in a couple of months. And vol is one year lows. It’s mostly due to there being imbalanced in options, so it’s mostly selling. But I’d say vol is a bit mispriced here. I do think that it’s not as if we’re going to sit at $10,000 and gradually go up. I think that the next year. We’re very likely to see $20,000. But I wouldn’t be that surprised if we saw $6,000 as well.
So the market, I think, is underpricing the swings, especially. And the market has a lot of different places where you could trade. But compared to the Treasury markets, or oil market where it’s more specialist trading, we have a lot of whales, that are sitting on what could be billions of dollars worth of Bitcoin, or at least hundreds of millions, but they don’t have a professional trading background. And whether they fancy themselves at trading, they wouldn’t necessarily use a VWAP or even ask a liquidity provider, they might just press the sell button. And that could take the market down 5%, or 10%, all at once.
So even though the infrastructure exists, and there’s a lot of different menus and methods to trade, we’re still going to be in a bit of this disjointed market, because people have large assets, and they’re not professional traders. And also, there’s a lot of leverage in the space. And if the market does happen to drop 10% quickly, you might stop out some of these groups that are borrowing dollars against their Bitcoin holdings, and could cause some of these serial domino effects of de-leveraging.
Dean: It’s really interesting to look at the vol surface, so to speak. So when we think about the pricing of all vol across strike and across time, and so I think what you’re referring to is there’s still some slope to the call side. Just correct me if these numbers don’t make a lot of sense, but it looks like at the money vol is in the kind of mid 50s. But as you kind of skew it to out of the money strikes, you can get to 60s and 70s. Is that approximately where you see things?
Richard: I’d say the smile is relatively symmetric compared to other asset classes, especially equities, I think, Bitcoin, I would expect it to have more of a call skew than it even does now. But currently, it’s a bit more symmetric of a smile.
Dean: It’s really interesting, you were mentioning the election before. The pricing of the election is showing up in just about every market, including Bitcoin, looking at the futures option, where they trade on the CME, you could easily paint a picture here of just the chaos that could be coming just in terms of the legitimacy or the perceived legitimacy of the process.
And what I’ve always said about something like gold is it benefits from a number of different things, it’s vulnerable to some things as well, but it generally does well in chaos. And it would seem to me that Bitcoin, at least potentially, is something that you want to have in a world where money printing is accelerating, the jargon of things like MMT, is becoming more and more mainstream.
How should people think about Bitcoin in their portfolio? In terms of, you said, it’s somewhat financial and somewhat technology. On the financial side, what are the attributes of it that you think in this day and age in this macro climate, are most valuable in terms of having it as a piece of your portfolio?
Richard: The word chaos can elicit a lot of different imagery. And I think that we would traditionally picture times of war, looking back, hundreds, if not thousands of years, gold prices would be going up when two different groups are at war, and the bond yields of each group would be increasing.
Ultimately, whoever wins, their bonds are worthless, and others yields gradually come down and gold prices go down while they’re each paying for mercenaries using the gold since they don’t trust each other’s fiat.
In this day and age, hopefully, we’re further away from war due to the consequences of having a real war, not a trade war, or more of a pedestrian terrorism type event. I think that the chaos that’s happening is more of a chaos based on a loss of trust. And it’s not just a lack of trust in the current president. It’s more of a lack of trust in the government’s lack of trust in the two party system, a lack of trust in capitalism, or what’s what system we are meant to be using, and a lack of trust in the way some of the largest technology firms operate and handle our data.
So I think that gold isn’t quite as special of a hand raised against the current regimes they stand, as Bitcoin is. And I think Bitcoin in the way that it acts as a form of a hedge from a financial standpoint, is almost secondary to the way it just allows people to bank themselves, it has the same sort of sentiment in terms of being able to hide other forms of data and provide better forms of governance than our existing methods.
So I think that we have a very unique blend of chaos. That wasn’t just apparent in the debates last night. It’s apparent in each country and this sort of populist revolt, that’s been occurring globally in so many different ways. Whether it’s in the US, the Middle East, China, Taiwan, there’s a lot of reasons for people to be afraid. And when they can’t go to their governments to trust them, they can’t go to their corporations.
There’s some sense that crypto is a way where they’re able to hide their assets, and also hide their information that other sort of platforms aren’t giving them the same confidence.
Dean: One of the things that I was reading about is this initiative on the central bank side, the central bank digital currency. And I’m curious, in your rendering how a central bank looks at the crypto space. And if you can just tell us in the context of a central bank, what exactly does a digital currency mean? Is it a store of value that’s different than the dollar? Or is it just a means of transacting that’s more modern day than we have in place now?
Richard: I’d say it’s more of the latter, if we could snap our fingers and have US dollar digital currency. Same with the Chinese currency. I don’t think anyone in the cryptocurrency world would call those cryptocurrency or even digital assets in the way I usually think about it. It’s more just that, clearly this system, I wouldn’t say it’s broken. It’s just archaic. The fact that you can’t send someone $20 without it costing $20 and taking a few hours or taking a few days, and $80 if you’re sending it across borders, and you can’t send anything on weekends or holidays.
This doesn’t seem like technology of 2020. That sounds like something that was available 20 years ago, and we’ve moved leaps and bounds and every other type of platform that requires technology, but there’s been little to no improvement on the way we move money around.
So I think that creating a digital currency, instead of it being that it’s suddenly the crypto dollar, it’s more just doing a needed update to the current system of moving money around. But because it’s so important to the financial system to get it right, it can take five years to do something that you would otherwise think that would be able to figure out within a matter of a year.
Dean: Is the crypto space, Bitcoin and Ethereum and so forth, are central banks looking at that as a threat? And if so, does that figure into your calculus in terms of the future path of Bitcoin.
Richard: I think that when something is a highly credible threat, you can either try to eliminate it, or partner with it and grow with it. And I think that we heard that the US, the CIA tried to shut down Bitcoin in 2012 and realized in the process that one, they wouldn’t be able to shut it down. It’s not one person, or even a group of people that they could go after. And two they realized that having everything on the blockchain being 100% transparent, does provide a nice trail for criminals, to go after them.
So I think that even though the gut instinct would be for governments to say that cryptocurrencies are dangerous, they’re creating paths for criminals to use these instruments and also creating inflationary events. And there could be currencies that are competing with sovereign currencies.
I think that the more recent trend has been that they should look at these noble qualities of cryptocurrencies and try to mimic them. And like we said about building to send money quickly, transparently and more efficiently, and then also some of the other technologies such as decentralization and use of the blockchain, whether the central bank is going to use those concepts for their own currency, I think that there’s a competitive standpoint that if China ends up being the winner of all things digital assets, that’s going to get them closer to AI, and that’s going to disrupt the US ability to be competitive on the long term.
So when it comes to technology, as a whole, even though cryptocurrency doesn’t come up on the radar as high as some of the other things in the forefront of tech, I think that there are a lot of interesting things happening in the space and a good amount of funds being put forth towards these innovators.
So I do think that even a bill passed last night in the Senate, that in order to remain competitive on the global tech landscape, we need to be a bit more forgiving in terms of the legislation on cryptocurrency.
Dean: So as we finish the conversation and want to thank you for taking the time, I’ve learned a lot and I’m sure our audience is going to really enjoy consuming this episode as well.
When you think about just owning Bitcoin. We’ve talked a little bit about options. Your firm GSR has done some innovation on the structured product side, there would seem to be a number of different methods to essentially have long delta, long exposure.
How should someone if they’re thinking about getting into the space, and maybe not trading in and out of it, but what are the most efficient mechanisms? What are the choices available for someone to essentially assume long exposure?
Richard: So this could be a whole podcast on its own, knowing shark fins and other structures yourself and your company has come up with over the past decade or so.
Right now, as I mentioned, I think there’s been an oversupply of options. And I think there’s a lot of vol catalysts. So buying three months 25% out of the money calls, keeping it simple, outright option is kind of the Ferrari, it’s easy to enter, easy to exit, much more of a pleasure to monetize and doing something that has more structure.
But there are other reasons why you might come up with a structure that looks more like a call flyer, a condor. Since there are kinks in the surface, you don’t have as many speculators that are providing liquidity across the smile.
So if the smile is disjointed, you might want to buy the piece of the smile that’s the cheapest, sell the meat that’s a bit more expensive, and then by the tail. So whether that’s a call fly or a condor, there are ways where you could add some value via some smart structuring.
But I think especially for your audience, if these are groups are looking to do it on the company’s balance sheet, just buying outright options is a simpler play. And it’s going to be more something for retail with some time to look at the surface to do something more iterated, or just waiting another six months or a year. And I think we’ll have the type of liquidity where more moderately sized funds can take a more iterative view, using options than let’s say, as opposed to getting more creative on how to buy crypto other than just futures or calls.
Another thing I’d advise is look at the other parts of the space whenever Bitcoin is rallying 3% over the weekend, and we’re getting calls from the media, there’s usually another currency that is driving the move up 20 or 50%. They’re certainly starting to be credible groups that are building valuable companies within the space. So while Bitcoin is deserving of a lot of attention, I think we’re going to see more discussion about some of the other projects and decentralized finance in general. And I think there’s going to be maybe more risky returns if you look outside of Bitcoin in the space, but higher risk, higher reward makes it worth your while to take that look.
Dean: Wonderful. Well, we’ll leave it there and rich, it’s been great to reconnect. Thanks for your time today and sharing your reports.
Richard: Likewise, it’s honor to be on your podcast.
