Crypto Credit Markets Will Rewrite Risk Management | David Grider

Transcript

Introduction

But I think broadly you're going to see a bigger credit market start to emerge in crypto. Historically when markets go down, people would just be in you're in Bitcoin, you're in ETH, and you're in all these altcoins and everything's just a derivative of the beta of the overall market. But you can use different parts of the investment universe to get different types of uncorrelated diversified returns. You can get credit like downside, but crypto like upside. The biggest theme for for this year and potentially the next year or so is >> this episode is brought to you by Vanex Semiconductor ETFs. You'll hear more about the VANX semiconductor ETF, ticker SMH, the largest semiconductor ETF, and its newer VANC Fabas Semiconductor ETF, ticker SMHX, later in the show.

Blockworks Digital Asset Summit, crypto's premier institutional event, is back in London this October 13th to 15th. You've got top speakers from Black Rockck, Circle, Coinbase, the UK Parliament, and Athena all under one roof. I'll be there as well hosting a live forward guidance episode with Quinn and a few others. So if you want to see us record in the flesh or meet some of the other legends on the forward guidance community, this is your shot. Notable macro names like Michael Howell of Crossber Capital and Jeff Park are already confirmed with more coming. There's also a VIP dinner on the 13th that will sell out fast. That's for speakers and VIP ticket holders only.

It's at Old Billings Gate in London. Use code Ford 100 for 100 pounds off. See you there. Nothing said on for guidance is a recommendation to buy or sell any investments or products. This podcast is forformational purposes only and the views expressed by anyone on the show are solely their opinions, not financial advice or necessarily the views of Blockworks. Our hosts, guests, and the Blockworks team may hold positions in the company's funds or projects discussed. All right, everybody. Welcome back to another episode of Forward Guidance and joining me today is David Grider, partner at Finality Capital Partners.

David, you're actually on a panel with me at Permissionless a couple months ago. We talked about digital asset treasury companies. Um, we're joined by a whole host of others and I I was just reflecting and I really enjoyed our conversation and also before the panel we had a really great macro chat and learned a bit more about your process and your background and I was just like oh man I got to get this guy on the show again just like you know sit down and properly chat. So David really great to have you on the show. >> Well thanks Felix. It's an honor to be here. >> So I would just love to hear a bit about your background of how you ended up where you're at now. You're you're running a crypto liquid fund. Um I know you also have some some venture in there

as well but yeah you are a institutional allocator in the crypto space. How did you get there? What's what's what's been your journey? Yeah, you know, I um I think like many folks, I started in traditional finance uh small investment bank out of school, did some equity research, equity capital markets um and then I went to PWC, did some consulting valuations for, you know, a bunch of weird asoteric different securities like debt equity across the capstack, CLO, CDOS's and that's when I got into Bitcoin was like around 2015 and uh this is like 600 bucks uh five 600 bucks for Bitcoin and I was like, you know, I can figure out how to value Bitcoin. and I can invest in it back in that time.

Started investing in ETH after the Dow hack. Uh you know invested with some friends during the ICO wave and we started a small fund in the 2017 18 cycle. It was just like five million bucks mostly our money and um you know we we did pretty good. The fund did well. The problem was we weren't big enough to cover all the outside costs. It's very expensive to run a fund. So I went to Fundstrat and I think everybody knows Tom Lee these days. He's he's uh he's really all over the place and driving a lot of price action, particularly neat. And um you know, I ran Tom's crypto research business. I was head of digital asset strategy for a couple years. And uh that was great because you know, I got to go on Wall Street and be one of the like, you know, voices that was like actually writing

about tokens during the 2020 2021 market cycle. And there really wasn't people covering tokens on Wall Street. You're starting to get that now with the coverage of the treasury companies. uh but you know a lot of big institutions were reading the research and then I went to uh Grayscale was head of research at Grayscale uh launched some of the exciting trusts Salana DeFi fund the equity stuff uh got back to investing in another digital asset fund and then launched uh finale liquid opportunities fund we call it flow uh about 14 months ago so actually last in the second half of last year and it's been a great ride ever since >> amazing so yeah a lot of crossurrens there between the world and the crypto world which I think is a a really a nice jumping off point for understanding.

Obviously, you know, our audience here is a lot of macro first people, trady people that are starting to become more and more interested in crypto as it just integrates itself into the trady world. Obviously, we have stable coins. We have Bitcoin as its own entity. We have these digital asset uh treasury companies now, which are becoming a huge thing, which we obviously talked about in that panel. Um, before we get into the thick of it, I would love to just hear I I keep trying to, you know, find people that are really in the weeds running a, you know, a crypto liquid fund and and some of the more complex dynamics associated with that because it's it's a very high volatility market. Yeah. I would just love to hear like what does what does it look like to be, you know, running a liquid fund and how does that compare to

Running A Liquid Crypto Fund

something on the Trady world as opposed to that? >> Yeah. You know, I actually don't think of us as a crypto fund. I think of us as a hedge fund that invests across the digital asset industry. You know the way we focus the strategy. I think it's interesting. You could look at you know like a sector specific fund. There's biotech but maybe energy is the best analogy in the traditional world. You you got an energy focused fund invest in the spot commodity that could be Bitcoin ETH etc. They can invest in derivatives around it futures options but they can also invest in the companies. It can be um you know a small cap EMP, it could be a large cap major, one of the Exxons, and it could be across the cap stack in debt and equity. And you know the way we try to approach it with our fund is

maybe a little different than most other what you'd call crypto funds. We try to approach it from that perspective of you know there's this new industry uh you know there's a lot of interesting opportunities both across the traditional world and then the digital asset native world and we can invest in these different securities or you know non-security commodities that we can take advantage of of the market uh environments and and that's kind of the way we kind of look at the universe and then like you know how you approach that strategy and the framing obviously has a lot of macro and and fundamental um you know underlying uh you know things you have to do to approach that and and hopefully you know get good returns for your investors. But that's that's generally the the overview for our thesis.

>> How do you manage the risk of it and how do you measure success? because this is something I've been thinking a lot about which is you know just trying to understand risk adjusted return within the realm of something with such high volatility like you know does it me does it make sense to benchmark yourself against I don't know like the S&P or something like that or like a 6040 portfolio like yeah how do you think about this just this notion of riskadjusted return in the digital asset space and and how are you benchmarking that success >> you might have asked one of the hardest questions for any digital asset fund what do you benchmark yourself against it's it seems like it could be simple, right? I don't think anyone really knows the right answer. Uh I think for the simplest one is like Bitcoin, people

will say Bitcoin. Um but there's also a lot of recency bias. So like you know if it was 21 people might want you to benchmark versus ETH. They might want you to start benchmarking versus ETH and uh you know three months from now they say I could have just bought ETH for the last three months, right? Um but you know the answer for what we do we actually we don't we we we're pretty transparent. We don't need to give when we, you know, talk to investors, we we give them almost every flavor, right? We give them what we think could be the main liquid assets. We do the indexes of the the multiasset indexes for crypto, the market cap weighted ones. Then we also look at trady and some of the fund indices and say pick your flavor. You can compare us to this. But but I think

most funds I talked to um most funds try to benchmark themselves versus like some like the Bloomberg Galaxy or some crypto30 index. You know, it's actually a funny thing though. I think you right now instead of Bitcoin versus Bitcoin because they say oh you know we own tokens it's more like equity investing. Um but I think you know right now maybe that's not the best place to be is a token manager and we haven't been playing there a lot. Um but you know I think a lot of folks fall into that bucket but it's kind of like being and they can outperform that bucket if you're like on one of these indexes but maybe they're like being the Russell 2000 manager. Maybe I told someone today it's like you know liquid in being a liquid token fund and investing against the you know the token indices and being

those like outperforming the Russell maybe you did great for that but maybe you should have just been in the NASDAQ right and uh so I think that there's some other you know areas of the market where you can play whether that's cross equities uh the other areas etc that are interesting that are more like the NASDAQ and we just want to be nimble and go across them. It's an interesting one because it's, you know, it's always this this difficult challenge, right, of of outperforming your your benchmark. And let's just use for like just what we've just said super simple terms. Okay, Bitcoin is our benchmark. So, okay, you have the situation where it just feels like the beta is the thing that has just been so durably strong, which has made it very difficult for funds of of any means that are trying to seek out this

alpha to outperform that. What do you what do you view as like the main sources of alpha for the crypto world as as like an institutional trader and especially for those that are listening that are maybe like a portfolio manager in the trady world seeing a lot of these things happening these digital asset treasury companies stip coins yada yada yada yeah what are the main sources of alpha that you see in the crypto world breakthroughs begin with semiconductors with over $23 billion in assets under management the VANX semiconductor ETF ticker SMH is not only the largest semic onuctor ETF, but it has also outperformed the next largest semiconductor ETF. It is built on an intelligently designed and constrained index that includes the whole sector

VanEck Ad

stack from design to manufacturing. Historically, this unique construction and methodology have helped SMH outperform its closest ETF competitor. Check out the table below. Go to van.com/smhelix to learn more. As always, investments in blockchain technology involve risk. Terms and conditions apply. Do your own research. >> Well, I think the main source of alpha is just being able to manage risk. Um, you know, I think a lot of folks really got hurt in obviously January and February. Um, you know, our strategy we have, you know, my partner Kamo is like a quant genius. We have a macro signal.

Main Sources of Alpha

Uh, we took a lot of risk off you based on that. It's discretionary signal, but we went to, you know, 50 70% cash. Um, the end of last year, beginning of this year, that helped. And I think, you know, one being able to compound and manage risk both with managing your gross exposures when when everyone's bullish maybe and trimming there. Um, but also, you know, I think in the strategy mix is also an important thing. So, you know, you gota you can have a strategy mix that can be diverse can give you diversified returns. So historically, you know, when markets go all these altcoins, and everything's just a derivative of the beta of the the the overall market, right? And to some degree, that's a derivative of the beta

of high yield and of equities, right? Because macro cycles, crypto certainly moves together with those on the risk curve. But now with the way that the market is maturing things that we're looking at with our strategy and we've done is you know like I said we didn't want to be in cash in in you know the beginning of the year. So in February we went and bought the micro strategy prefers and you know you can use different parts of the the investment universe to get different types of uncorrelated diversified returns. So we got paid 9% effective to own those. We uh then got they traded up on us some because rates were you know uh people were pricing in a bunch of Fed cuts right because the world was falling apart uh you know at that part of that beginning part of the year uh and then

we said okay like we're close to the bottom right maybe we're we don't know Bitcoin could fall out you know go to 60k from here it's like 80 how do we want to get exposure well we can use other instruments like micro strategy senior notes right and we could get cryp crypto upside credit downside and then go you know as the market came out and in April, May, you can go back into directional lower long just digital asset exposure. But I just think the two components I'd say are, you know, one obviously again managing your gross overall risk and then two managing your risk within your portfolio and across your strategy. That's how we approach it, but there's obviously a lot of ways to do it.

>> I'm curious if you've noticed this seems like something I've noticed over the last couple years, which is okay, the super simple way to describe this is either we have an alt season or we don't have an alt season. And what I've noticed over the past couple years, and I'm curious if you've seen this in like the quantitative correlations in in crypto assets is it feels like we've seen this maturation of the asset class or you know we have some things that are doing well, some also are not doing so well. Have you noticed that in just like correlations as you manage them through it? >> What's the saying? History doesn't repeat but it rhymes. Um I think we've actually had a great alt season. I think the old season has just been in equities, cryptoreated equities. I mean, if you look about what's look at what's

Have We Had an Alt Season?

happened in um you know, you could one say the DATs, but even Circle, Coinbase, Galaxy, um a lot of the miners, right? You've had an alt season in the Tradfi cryptoreated universe. And um you know I think because it doesn't show up in your DOM chart right your you know your coin market cap bomb chart of tokens uh maybe you don't maybe it's not as readily apparent to everyone but I think I think being able to realize like where the flows are coming from and then where the like fundamental dynamics are at play.

So like the I mean why do I think we haven't had as much of an alt season in tokens? Well, I think you've seen you have seen unique tokens have great outperformance um on their own, but it's a just very select handful and it's usually the ones that have better fundamentals I think is what we've seen lately. It's been, you know, ones that are behind this ETH narrative and trend. But a big part of the problem is things just get so sold from the venture universe in the capital allocation there, right? you got 80 billion of venture, maybe there's, you know, 20 billion of fundamental hedge fund money trying to buy that and the crypto's token sphere and um it's just a mismatch, right, of of supply demand fundamentals. And uh you got to go where where you know on trapi the flows are coming in and outweighing the supply of

trapi related digital asset investments and you just gota you know that that will flip back, right? Like we want you'll want to go back to tokens at some point and be there. Uh but you just have to kind of manage you know what what the current environment is over time. >> Yeah, it feels like that's been one cross is just just yeah Apple going into the 35y world less so into those like all chain alts and at the same time you just have that constant supply issuance from the VC side of things. I'm curious as well like another crosscurren is just the derivatives evolution in the crypto world. So it felt like the last 5 years or so it's been so predominantly like you know per market driven um perpetual futures for those that don't know what those are. And we've obviously had this

Evolution of Crypto Derivatives

institutionalization of crypto assets. We now have very liquid options on like Black Rockck ETFs and that sort of thing. And I'm I'm curious as a as a professional allocator, how have you seen that evolution in the derivatives market of the crypto world? Well, yeah. Look, I think um it it's it really started in 2017, but it's grown so fast, right? And it's matured so much more in terms of infrastructure. Uh and then counterparty reliability. Um and I think, you know, the TrabFi adoption of these traditional secures is really the next the next element of that. You know, we've gone from people trading on BitMX to get your Bitcoin leverage. You can do it on IBIT right through you know you know we use JP Morgan as our broker and um you know

I think that that is as you see more assets that become adopted as both um you know ETFs but also this the futures markets you're seeing Coinbase futures and per being rolled out uh I think as that continues to um and I think that trend is going to happen a lot faster right there you know obviously the regulatory environment now is such a big tailwind for that right it's really it's really comes down this next leg really comes down to this regulatory environment. Um and you're going to want and I mean with these DATs I mean you talk to the people who are in these markets on the derivatives markets they're seeing for the first time people I talked to big traditional funds that are investing in DATs and shorting and

hedging actual per uh and futures on the underlyings for tokens. you probably wouldn't think those folks would trade but because they think they can get some relative value or some kind of basis opportunity in that versus the underlying like you're creating more liquidity and more flows in that underlying uh just through that. So it really is like you know I think the biggest theme for for this year and potentially the next year or so is this just the trafficy convergence and the things that are going to do well are the things where you get the convergence right it's it started with ETFs Bitcoin they became DATS like Micro Strategy Sailor but also with ETH and same thing here and then the derivatives in the futures um I think that stratified convergence is going to be the next thing and then the final piece of the is

going to be the adoption right there's some projects that I've seen on the venture side that are you they should have a lot of big institutions actually building on them. And um that's going to be like the final piece that actually brings both not just the flows and the the accessibility but the fundamentals to bear uh from for letting these become you know much larger markets than they already are. >> Yeah, that that vignette you just had of longing the DAT and shortening the purpose is really interesting comparing it to the last couple cycles where trying to just quantify the amount of froth in the system. Historically, it's like, okay, well, if we have, you know, 100% annualized funding rates, it's clear we're getting to that froth, but okay, you're just telling me here that the froth could actually be in different vectors, which is interesting because

Quantifying Market Froth

you're having actually more shorts on on the per side of things that that might skew it a little bit. So, yeah, like how do you how do you measure and quantify just the froth in this new era of convergence that you just described? >> Well, it's a good point. You know, look, we we in the venture fund, we invested in I should mention Finale also has a venture fund. I run the hedge fund. We have a venture fund that does preede seed series A. We invested in Athena early on. So we obviously that basis trade is a big flow dynamic for um you know suppressing to some degree because of the flows uh how how much basis will blow out right and you'll see that too with on the trades whether it's CME you know a lot of these flows if the basis is positive they'll short the future go

into the uh ETF and that's why you can see such big ETF flows for Ethereum or or others. Um how do you measure froth? I think look funding rates and bases are are certainly one, right? That's something I always want to watch over like a medium-term cycle, right? When they hit 50 and, you know, they're blowing out to 70 like they historically have, it's usually marks a local top. Uh, but you can't really, you know, maybe you want to lighten risk there and trim. Uh, but that's one that's certainly one component. Um, you know, I think another measure of froth is, you know, when you see some of the more retail dominated names start to really have, you know, I I would say more blowoff top type, you know, medium-term blowoff top moments, whether it's the Ripples, the, you know, the Stellars,

right? The non-institutionally owned names, you can get a sense there. Um but I think and people have pointed to DATs as froth uh in this cycle and I think you know DATs are one interesting component because you know you could really just bucket those in with you know like an IPO wave right whether there's demand for IPOs in a hot market uh and you saw that with spaxs etc. Uh but I think you know to some degree there there's froth in that segment right but that that froth actually is probably healthier froth for the underlying market than any froth because you know as you launch all these dats right the price impact for the underlying is probably still very positive right because now you have these public vehicles even if they trade

down right you know to be idealistic about whether that's a bad investment or good you have to really talk in specifics right is it a good investment for the person in the primary are you going to make money in the secondary bare market is it going to cause some underlying structural issues for flows like you know deleveraging and selling during a bare market for the underlying ecosystem but are they also going to create good underlying uh metrics of adoption right are they going to build businesses on top of the chain so there's a lot of different like you know nuances to how you think about what's frothy and what's good or bad for the different parts of the market and particularly for what investments you own.

>> Yeah, let's let's double click a little further into this DAP thing digital asset treasury companies. So obviously we had this discussion on that panel a couple months ago. We we had Tom Lee there which was awesome literally the day before he launched Bit Mine. Um very awesome. Obviously there's been a lot of success there. So okay I I feel like a lot of the main points have been you know kind of it's starting to be like beating a dead horse. But one of them that's sort of unique that I'm I'm curious on your take on is it feels to me like when you look at each of these companies in isolation as like an individual company you're like okay these are not that levered. especially the ones that are just, you know, doing the at the markets and and they're not even in the debt markets yet. Like it's

Measuring Systemic Risk

it's it's really not that lever compared to some things out there. But then it's like, okay, well, when you combine 200 of them, you know, do you have to view that differently that that you know, it's sort of like in on on its own, it's not that risky, but when when you look at the confluence of them all together, does that in aggregate increase the potential systemic risk and and how do you measure that? So, yeah, why don't we use that as a jumping off point? curious under your take on all that. >> Well, I think there's, you know, probably um a hundred billion of assets underlying NAV behind all the Bitcoin, ETH and soul debts and uh most of that obviously is in Bitcoin and micro strategy. You know, who is in terms of the leverage of the entire space maybe

they have like one maybe they have 10% or 15% probably less than than you know about that 15% leverage debt to equity on it. And um I don't think micro strategy represents a leverage risk. Uh and I don't think really the broader universe actually has room to lever up. So I think you could actually put more leverage. I'm not saying take it to 50% or 40, but you could put 10 you could put another 10 billion 20 billion of leverage on the entire debt market cap. I don't think any of the ETH debts actually have any leverage. Uh any of the large ones at least. So like there's there's actually room there for those to put on leverage and the quality or or the type of leverage is also what depends for what what risk you're going to create. Obviously, you know, there's

risk to the equity holder because you now have someone seniority in the capital structure. leverage inherently does create downside risk on the on the cap structure, but I think most digital asset investors are probably more concerned with the leverage that equates back to the ecosystem which is going to cause someone to default, have to sell or liquidate their assets. Uh I think that stage of leverage is actually like not really an issue at this point. Uh there's a lot of things where you can look at you know when this the term structure of the the existing credit come due. A lot of it doesn't come due for many years. A lot of it's very what's called covenant light, meaning they have um you know a lot of flexibility from their debt holders as to how they can manage things like collateral uh coverage uh like interest

payments and uh whether they default to choose whether they default or not. I think there's not really a lot of risk in the default of most of the debts at this stage. But you know I think that the you know maybe the risk to the underlying maybe comes more from uh if the navs you know you get a bare market look I've lived I was head of research at grayscale I've lived through both the GBTC ARM trade from you know nearly the beginning and through the cycle of it being obviously like many folks converted to an ETF and um I think the bigger risk for the underlying is not so so much a leverage liquidation um is it's really at this point right that could change right people can get very aggressive at different stages of the cycle. But at this point, I think it's

more just now fall below. You get people that are tired of the strategy. They say, "I'm just going to sell my spot." And then you have somewhat of a prisoner's dilemma where those fragmented guys start to sell. Uh but you know what? At that stage, maybe you do have someone like a sailor come in as a buyer of last resort if it's accreative to him to buy them up. So there's a lot of like dynamics that have to come into play for for thinking about this market. >> Yeah, I think the emphasis on nuance there is really important. It's it's not just this it's it's not as simplistic as it looks on the surface and okay so I want to I want to look into specifically the as we see this evolution into introducing debt markets into say the ETH debts which are all the rage right

now and to your point there there hasn't actually been any execution on that quite yet they're all still so far just doing the at the markets issuing equity we have not seen convertible bonds or prefers yet like micro strategy is doing so okay first question on the convertible bond side of things to my understanding one of the big reasons reasons why there's such low default or liquidation risk for Micro Strategy right now on their convertible bonds is because other than the initial ones that they first issued, most of these are at a 0% coupon. So there's very little interest expense. Um I'm curious on your take, how feasible is it for say these potential future ETH DATs to be able to issue converts at 0%. Is that just a unique thing for Sailor or is that something that's achievable for them as

well? And if not, where do you see those coupons sit and how that affects interest expense? Using a similar philosophy to SMH, the VANC Fabas Semiconductor ETF, ticker SMHX, goes even deeper, exclusively investing in fab semiconductor innovators designing AI infrastructure. Behind the scenes, we're talking high bandwidth memory power management chips, custom accelerators, and ultraast interconnects. the critical components that make large AI models run faster, smarter, and more efficiently. Go to vanet.comsmhx Felix. To learn more, as always, investments in blockchain technology involve risk, terms, and conditions

VanEck Ad

apply. Do your own research. >> Well, the reason they could issue for zero is because people are giving them um it's embedded in the optionality that they're purchasing, right? So because obviously uh a convert is a is a bond and then it's an option and um you know that that option value plus when you issue it is really what ma is what makes up for that interest rate delta that they're not paying. So the higher the volatility of you know presumably the underlying that translates to the underlying spot commodity Bitcoin ETH etc. That translates to the stock is really what you know gives them the ability to issue at better rates.

Can ETH DATs Issue Preferreds?

Coinbase but it's not just about the DATs. It's Coinbase too. They just priced a $2 billion convert offering. 0% I think was the rate. And I think it was uh I think they did two two expireies like a 27 or 29 and a 35. And um you know you had a I think one one had like a 35% premium and one had like a 55% premium. You know so that volatility is like an interesting component. I think the reason debt markets are eating this stuff up is because you know from a macro perspective I mean we all know like you know you're not yielding a lot with debt. You're you're getting eroded away in monetary inflationary terms. uh based on the you know obviously the way that the Fed be uh other central banks have to you know increase the money supply uh well really more the

treasury side of it now in the US but you know you're getting eat up in those terms and you can't get the returns but you can get credit like downside this is an area we're particularly interested in you can get credit like downside but crypto like upside so as an example um one thing we did there was a deal by Adam Bach who is obviously known for being an early Bitcoin founder and um you know he's at you know blockstream founder as well and um he did this uh bitcoin standard deal and we participated in that but we were interested in the um the senior notes which were convertible and then the prefers which are also convertible and like we thought those were compelling because you know instead of buying the

equity of one of these companies we could get through the debt markets you could get you know we're paid 1% of the senior notes uh I think It's like a 9% effective on the on the preferreds, right? And you can get a conversion, right? These things price at one nav roughly, you know, because Micro Strate trades at a NAV to the Bitcoin you so you get you get one NAV pricing and then 30% up from that on the on the conversion, right? And then so but you what you what do you have as the structure? You have an at the money put for three years, right? An at the money put and then you have a call option 30% up, right? for three years and it's like, you know, and by the way, the debt can be like 7x over collateralized,

right? So, you're not going to lose money unless it goes down. So, you're pretty much money good and you can get this put and call structure in this convert, right? You could be protected as debt and you can make money two ways. It could close and Bitcoin could go up, you can make money or it can close and the valuation could rerate like Micro Strategy's valuation and Bitcoin could be flat and you make money. So, there's just like unique, you know, if you're a credit investor, like a pure credit investor, that's compelling, right? And that was why they were able to do all said and told maybe a billion of credit on a Bitcoin DAT right across different instruments. Uh and I think that that's something you're going to see a lot more of.

Crypto’s Credit Market

>> Yeah. Okay. So as as somebody that can you know basically participate in any part of the capital structure various asset classes. So, I was going to ask like what what is the incentive for you to pursue that versus opposed to say just structuring your own options trade on like just like you know I bid options or something like that like what you just described sounds quite similar to just like a call option or something like that. So, is the reason that you're more interested in this because it's senior in the capital structure versus equity or is there other reasons as well? >> Well, I think the I think the reason to do it is it's cheaper pricing than you could probably get in the cryptonative markets.

>> Okay. I think it's safer and I think it's cheaper, right, to get a three-year call, three-year, uh, put. I mean, I think it's the effect of buying the spot underlying, selling it at the money call, uh, and then buying a 30% up call and then using that premium of the the call you sold to buy your put, right? That's how you replicate the structure. And I think it's cheaper to do it in this market, but you can also get the premium bump, right? So, that's the other way, the other advantage of it on the nav premium play. So there's but like doing this the ways to structure trades like this are kind of interesting if you maybe think you're late cycle or maybe you want to just manage risk. You don't want to take off all risk. You still want upside directional exposure but

maybe you just want on downside risk you lose some of your call option or maybe you just lose some of the interest rate risk because you're only going to pay 1% on that one or maybe spreads blow out on your preferred. Right? So maybe it's trading like high yield but maybe the spread goes a little higher. Right? So that's like your your marktomarket risk on those types of securities, but like it's it's a unique way to approach the digital asset market these days. And we think, you know, I think there's like in the credit space of crypto, not just because of debts, right? But I think broadly you're going to see a bigger credit market start to emerge in crypto. And I think that there's really an opportunity for three types of credit strategies that could be useful. I think there's going to be performing credit

that trades at much more attractive rates relative to what you would get in the broader uh traditional market because this market is misunderstood and hard to underwrite. I think that there's going to be convertible upside, right, for these convert deals where you can get equity like upside or crypto like upside and credit downside. And then I think eventually later cycle there's going to be distress. Hopefully there's not an FTX situation again, but maybe there's another Coinbase situation with some other company, right, where the bonds trade at 50 cents on the dollar. Maybe there is another FTX or Celsius in later cycle. You could see something like that emerge. So I think that this market is the the credit market I think is in cryptoreated credits is maybe around 30 35 billion of of total outstanding size on what I'd call 300

billion of cryptoreated, you know, kind of more pure play equities market cap. And um I think it's only going to get bigger. >> Yeah. Have you started to game out some potential outcomes for that distress phase? I I've started to think about it myself of okay what happens when some of these you know more longtail DATs um start to trade at a discount to NAV what's what's the calculus for thinking about where that leads is it a situation where okay they will first initially start to try to buy back their shares and sell the underlying do we see event-driven funds come in in force and start to just you know buy these up and then unwind them capture that spread do we see the the bigger dogs like you know Micro Strategy and Tommy acquire some of these

What Happens When mNAV is Negative?

Um, yeah. Have you started to game that all out yet? >> Well, I think what you just gamed out is probably the main pieces on the chess board. Um, and I think that where people will start is going to depend uh what people will do depends where they start. If they don't have leverage, you you can without selling your your underlying, you could take on leverage. If you thought, okay, crypto's down 80% from here, I still have all equity. I can buy and I'm at a discount. I can put on 10% leverage here, buy back my shares in the open market, right? because I don't have any leverage and I could do that without selling. Um I could yes I could try to get acquired by Micro Strategy at some point because this happens in traditional markets all the time right tuck in acquisition company trades at a

15 PE another one trades at a five it's accreted to do the roll up because you know you buy at five you get value revalued at 15 in your book right and compounds your growth right that grows your Bitcoin or ETH per share or whatever and then yeah I look we saw that with Grayscale where you know they unsuccessfully some activist investors tried to force Gayscale to do the tender offer And um I imagine that that will definitely be something that happens and you'll see that uh some of these companies eventually get cracked open and have to be sellers at some point of the underlying which will you know as in all markets that will suppress the price even further. But you know it's going to all depend on what the market and macro environment is and um you know we'll see see how that all plays out. But those

are those are the main scenarios. I would love for you to explain a bit more the preferred thing now too because obviously Sailor started in the converts and now it seems like he's made a pretty strategic pivot to preferred. I'm curious why do you think that shift in focus and and how do you think about you know I was just looking at the recent earnings presentation for Micro Strategy and they're they're basically building this yield curve of various like duration based on the prefers market and it's and it's quite interesting but I haven't fully landed on the right way to think about it. Pure CV have a framework there. one, he like you said, he's just trying to build out a risk curve, right, for Bitcoin. But two, I mean, his whole model is, I mean, look, I think that it's kind of like a bank, right? What

Framework for Saylor’s New Yield Curve

does a bank do? A bank will take short-term deposits and pay lower rates. Maybe I pay someone one or two% and then I buy long duration assets, right? I make a longer duration loan, which is an asset to someone else, and I collect a net interest margin. in some ways where he's levering the capital structure. He's borrowing at lower rates um in in in Bitcoin per diluted share terms, right? And then he's buying more Bitcoin which is a long duration asset. So he collects a net Bitcoin per diluted share margin, right? And uh just like a bank, you can't be too levered. You can't have loans go bad. Can't have your collateral default on you, right? You squeeze your equity holders. It's the same in a sense model. So I think what he's doing right now at this stage is he he's issued the

the equity market a lot. I think that some of the Micro Strategy shareholders are maybe not as happy with him as much as he's been selling on on the ATM. But I think also the way it traded down after the announcement or last last earnings call. Uh partially the markets were a bit weak, but I think some of that was also the market maybe saying, you know, I'm worried you're just going to lever me up and Bitcoin's going to go down, right? and you're not going to be able to tap enough to raise to grow your BTC yield. And you know, obviously the value of of any of these DATs is really derived in the ability to if they can successfully grow my underlying Bitcoin, ETH, etc. per diluted share. And the market was effectively saying, you've tapped out of your equity ability. Sarah

was trying to say, no, no, no, we think it's cheap like a company. We're not going to we're not going to sell shares when they're cheap. uh we want to sell them higher two to four range and the market's saying we don't believe you. We're kind of worried that you're going to just have to lever me up and that's the only way you can get access capital and maybe you won't be able to lever up enough, right? You won't get enough. There won't be enough debt demand because those have been less liquid still liquid in debt market terms but less in the at the equity less liquid options for raising capital for him. So I think that was like the dynamics at play. But from my standpoint he's not look it depend you have to always be in an evolving market environment. How much does he issue and does he issue too

much? Right? Like that's the job of anyone watching the space is to track like when the liquidation or not the liquidation because he's probably not going to get liquidated based on his covenants but when the what you'd consider NAV impairments are right how much you know Bitcoin relative to how much debt he's issued. Um but you know there's still you know from this yield curve perspective he does have everything from short duration closer to what you'd cons I don't want to call it a money market because the risk is much higher but I'd call it closer to a leveraged loan structure of a leveraged loan market because you get a floater short duration resets uh like a high >> yield product that they just came out with you're talking >> the most recent one that's right >> I think that's closest to a leverage loan and you know but this interest ring

when do you want to own something like that maybe you think we'll run into a hiking site Right now, you're going to have to you're still going to have so what do you get? You can reset your you can reset your rate. You might have some Bitcoin spread risk if that drives crypto down or what I would call Bitcoin risk premium right in the hiking cycle. But you're not going to take the duration of the longer term instruments, right? Um so like you know his other perpetuals those preferred some of these have you know eight 10 14year durations based on their interest rate which means um for layman's terms uh what percentage change do you get in the price of the par of the underly not but the fair market value of it relative to uh percentage change in the interest rate

or the discount rate applied to the security um and so those longer durations will get killed in hiking cycle right so he's given you the ability to have bitcoin related instrument struments that you can go across the different regimes. So maybe you thought rates were going to fall a lot. You might want to buy the longest duration uh meaning you know the perpetuals the ones that probably have the lower yield. So you'll get a higher duration on that. I know I'm kind of speaking wonkish bond terms but for your finance listeners they'll they'll probably understand what we're saying here. But it gives you this optionality to play unique instruments right across the capital structure and stay in a crypto mandate while also getting higher returns very collateralized relative to traditional financial uh credit

instruments. >> That is fascinating based on what sailor and micro strategy are are forging the path of where all these data can go and okay now we have these 2.0 versions that have all started to come out in recent months. they're at the phase of the at the markets. They haven't gone down this this path yet. Where do what do you think is the right path for them to go based on some of the lessons that like Sailor has learned through the years. Is it worth it for them to do the converts first and then go to the prefers market or just skip the convers? >> You know, I think it's it's always what is the market bear? What is the what is the current market environment and then what are investors going to demand for your capital needs at any given time.

What Should Saylor Do Next?

right now. I think these guys are issuing equity because they can. It's the best and easiest place to issue. Um, you know, I've seen some folks start to issue converts. I look, as an investor, for me, what do I want? I prefer to have a senior note sometimes collateralized. Usually, they're not um by secured collateral plus unsecured collateral, right? That can protect me. Um, but you know, you don't always get that, right? Most of the time they're unsecured. Senior notes is what you see most in the market. And um you know sometimes they're actually structuring these recently with more of an eye towards what you'd call the the traditional kind of um convert arb uh funds in the traditional market who will get you know some kind of prepaid forward or

something where they can hedge out and do the convert the traditional convert arb kind of play. Um you know but me I prefer to own them directionally to get directional digital asset upside right. Um, so that's, you know, one thing, but I think, you know, if the market continues on a tear and there's a lot of demand for this type of capital, I think you'll see restrictions lessen, but you're obviously not at that stage for a lot of the alternative ones because again, there is no credit on them yet, which means that it's still very hard for them to get credit. And it's going to be much more difficult for them to get credit than it is like I think in crypto land as we've seen in prior cycles. Like we've all lived through multiple crypto cycles where BlockFi just gave credit to anyone or Celsius or

some of the desks gave you credit or some of the lending protocols gave you too much, right? Were reckless. I mean, in the in this traditional realm, you know, for these issuances, you're going to have actual people underwrite these credits and they're going to be much more stringent with the with the credit requirements. And I think so far that's why you haven't seen a lot of credit in crypto. Plus, the rating agencies haven't turned on yet. And they will. Trust me, the rating agencies are going to come. They're going to start to rate these credits. I've talked to the banks about it. They're going to start to rate them. Uh, and I think once you hit that and people start to rate the credits, they start to really understand it better. Um, I think you'll you'll see more of a market develop and you'll see

more assets uh more folks get get financed in different parts of the capital structure. >> Want to step Peters here a little bit, zoom out a bit and just understand your high level thoughts of the crypto industry. And I know that at your fund you have this high level macro overlay that that you use to then jump as like a jumping off point in the crypto industry. So, first question is, what does it look like to have like a macro overlay and then use that as like this discretionary view into crypto? Because it's something I think about a lot. I sort of feel like I operate in that way intuitively as an individual writing my personal book. So, I' would love to just hear like what does that look like professionally?

>> Well, crypto is a macro asset of course. Um, and I think like a lot of listeners, they probably will understand that liquidity is a big driver. Uh Michael How's obviously been the the most forward with this and is definitely like the best uh at liquidity data and the influence on on uh bitcoin and other digital assets and and risk in general risk assets and broader financial assets in general. So we have you know look we take we take different macro liquidity inputs and my partner Camel has developed signal on that. It's a discretionary signal and we use that to think about every month how how we want to manage risk whether you know we should be more risk on or risk off. Um and that gives us like a you know a forward-looking view but you know like you know we have our own views as well

on you know what we think of the macro environment that translate down into like our strategy approach right and how much you know how we want to construct the risk that we have within the portfolio whether we want it to be more directionally long whether we want it to be more absolute return focused and some of the credit stuff uh and then just where like the different opportunity sets lie uh based on kind of what you think you know is is going to be happening in market and you know I can say earlier in the year and you probably know this because you read one of my notes at least from my investor letters we you know we were very bearish on the dollar and you know that was you know structured with a lot of you know the liquidity flows and the stuff that

happened with obviously the treasury QE um and we thought you know that the rates picture could improve relative what's being priced has improved as much on the short end as you want but we think the longer end is certainly started pricing a lot better with um the recent you know speculation and changes of of the the Fed structure Um and that you know that liquidity picture probably still has a little room to continue improving the M from a macro standpoint depends on what you know as a liquid investor it's always about time horizons right um you know and positioning as well matter and um you know right now or is you know could you see a hot Fed print inflation and people start to price in again one of these you know uh the Fed's going to have to be on hold more even though the composition of

the Fed's improving right the stagflation they price these in every four months or so it seems like and the market That's a backst step eventually but like you know you could have some rerating from that but you know from a macro standpoint like broadly over the next you know year end currently our view is still fairly positive for these kind of positive liquidity tailwind um dynamics. >> Yeah, we also kind of mentioned it's like I I hear this language of like there's there's a little bit more to go. So I'm curious like based on that framework, what's really interesting now is that based on everything we talked about about these different, you know, duration exposures and views that you can take and different parts of the capital structure, you have this much more sophisticated toolbox at your disposal for somebody sophisticated like yourself. It's not just all right 100%

Managing the full Spectrum of Tools

long Bitcoin or I'm in stable coins. You have this whole toolbox now available. And yeah, I would love for you to just paint a picture a little bit more of like what that starts to look like. I know you've been interested in looking into say you know like cryptoc corporate credit opportunities um stuff like that that has a bit more of this downside protection but still that upside exposure. Yeah. Unpack and give some color around what that actually looks like. >> Yeah, I think I think you're right with toolbox, right? And it it you can use it both AC both across, you know, for risk management but but even across assets like eventually let's say I wanted to be right now, you know, we we've caught the ETH rotation pretty well. um like a large portion of you know our fund is in is in Bitmine uh BMR which we we got

into the deal of and obviously Tom Lee is just having worked with Tom worked for Tom he's just a great operator the execution's great but like you know I'm I'm looking forward to the day where I could buy a you know an ETH related credit on his on his capital structure he doesn't have it yet I don't know when he's going to or if he's going to but I would love to own that instead of maybe a Bitcoin credit if I have a directional if I have a directionally better view on ETH relative to Bitcoin uh on the underlying market, but also if I just wanted to reduce risk overall. Um so that's like one interesting thing. You can use the flavors to say I have a better directional view on the underlyings or even on the businesses, right? Some of the miners, some of the

other companies that are really coming out. Uh by the way, we're also going to be very interested in as the universe of companies that goes public grows. You know, I would love I'm going to love to get a look at the Gayscale IPO. I'm going to love to see what coming out with Kraken. um these things are very much you know it's not just DATs that we're interested in right we're interested in the real businesses that are going to come to market as well like the circles like the Coinbase like the Galaxies we think there's a whole wave of that to happen as well um but back to the credit side like it just gives you this the tools to say I can dial up or down my risk across the market across different instruments or different underlying themes and flavors and across different macro regimes as to whether I

want to actually be long you know duration in a rate cutting cycle or I think I'm going to get better exposure being in crypto underlying because the rate cutting cycle is going to be good for it, right? Um or just a hedge. Uh you know, maybe next cycle maybe a good hedge if the rate markets are if if we think the Fed's going to just start hiking like crazy like 5%. Maybe you should go long circle >> because >> circle will benefit from a net interest margin store, right? it's going to have an improvement and you could be long a crypto uncorrelated hedge in your portfolio and you could be long your crypto and you could it you know I don't want to call it risk parody but in traditional finance you can do risk parity which is you know you can have you know uh you can you can be long you

can be long rates or short rates you bet rates are going to fall and you can be long risk right and those can balance each other out and um so there's more much more ability to have just like interesting portfolios I mean another thing we've done is we've used traditional um traditional uh instruments to hedge like the VIX for example. So we've bought call last last month we bought calls at the end of the month on the levered VIX and they actually this month the start of this month they traded up on us quite a bit because you know the market started to sell off in the beginning of this month. You could argue maybe that's people trying to frontr run the seasonality uh into last month and the beginning of this month because August is typically poor. Uh but those

actually cushioned the downside of our portfolio because those calls we bought when crypto traded off because of it, they were up and made us money. So there's there's just so much of a traditional tool kit you can use across tradine nowadays uh to to manage risk in different ways than has ever existed in quote unquote what a crypto fund would do. And that's why we say we're a hedge fund, not a crypto fund. >> That's so cool. I love that. It's it's cool to see it start to emerge. Um David, it's really good to get you on the show. Enjoyed that a lot. really cool to hear how sophisticated traders like yourself are evolving as these tools come out. Um, where can folks go if they want to see more of your work or research?

Final Thoughts

>> Yeah, I mean I think the easiest uh just follow me on Twitter uh david_gride gi. Uh we have a website finality. Capitalap and um yeah, that's probably the main places to find me. >> Awesome. All right. Well, thanks again for joining us. Really enjoyed that. >> Thanks a lot.